Re: A message from Prof. Auerbach

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(email exchange)

Robert has it wrong.

There are excess reserves because the Fed has decided to not do what it used to do, sell or ‘reverse out’ its securities to offset operating factors that caused reserves to increase.

These operating factors include Fed purchases of securities.

The reason the Fed would ‘drain’ excess reserves was to keep the interest rate at its target rate.

By paying interest on reserves it can accomplish that without selling its securities.

Reserves are functionally one day securities, as all treasury securities are nothing more than deposits at the Fed anyway.

And previous concerns about the Fed running out of securities were also addressed by being able to pay interest on reserves.

The idea that banks hold reserves (for any reason) ‘instead’ of lending is nonsensical.

All that paying interest on reserves does regarding lending behavior is increase the rates banks might charge for loans.

As always regarding the Fed, it’s about price, not quantity.

With a 0% interest rate policy interest on reserves discussions are moot anyway.

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> &#160 J wrote:
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> &#160 Auerbach’s idea: stop paying interest on reserves. What do you think? J
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Where’s the Stimulus

by Jim McTague

Feb 2 (Barrons) — University of Texas Professor Robert Auerbach, an economist who studied under the late Milton Friedman, thinks he has the makings of a malpractice suit against Federal Reserve Chairman Ben Bernanke, as the Fed is holding a record number of reserves: $901 billion in January as opposed to $44 billion in September, when the Fed began paying interest on money commercial banks parked at the central bank. The banks prefer the sure rate of return they get by sitting in cash, not making loans. Fed, stop paying, he says.