Banks’ behavior appears more consistent with the standard Keynesian model of the liquidity trap, in which demand for reserves becomes perfectly elastic when short-term interest rates approach zero. But the portfolio behavior of banks might shift as the economy and confidence recover, and we will need to watch and study this channel carefully.
Another uncertainty deserving of additional examination involves the effect of large-scale purchases of longer-term assets on inflation expectations. The more we buy, the more reserves we will ultimately need to absorb, and the more assets we will ultimately need to dispose of before the conduct of monetary policy, the behavior of interbank markets, and the Federal Reserve’s balance sheet can return completely to normal.