Comments on EconWeekly: The Fed's new tools (II)

Great article/summary.

2008-04-25T10:53:00.000-05:00

Great article/summary.

The banking act of 1935 gave the Board of Governor...

2008-04-24T18:00:00.000-05:00

The banking act of 1935 gave the Board of Governors permanent power to fix the reserve ratios applicable to member banks within limits set by Congress.

Raising reserve ratios is regarded as adding to the banks sterile assets. However with open-market operations, the individual banker is only aware that his bank has an adverse balance of payments. Both operations result in a decrease in the banking systems earning assets.

"The concern now is that the Fed may run out of Tr...

2008-04-24T17:55:00.000-05:00

"The concern now is that the Fed may run out of Treasuries"

During 1936-1937 the reserve authorities raised the reserve ratios in an effort to reduce the huge volume of excess reserves in the member banks, while at the same timer being forced to continue purchasing operations in order to assist the treasury inn its deficit financing.

The percentage of reserves to note & deposit liabilities hit 91.1 in 1941.

"This allows the Fed to pursue its recent strategy...

2008-04-24T17:51:00.000-05:00

"This allows the Fed to pursue its recent strategy of providing liquidity to the banking system without increasing the MONETARY BASE"

The monetary base is not a base for the expansion of money. 3/4 of it is currency. An expansion of currency held by the non-bank public is deflationary. The only base for the expansion of money are the member commercial bank legal reserves.

"Reserve balances are like checking accounts: they...

2008-04-24T17:46:00.000-05:00

"Reserve balances are like checking accounts: they don’t earn interest."

That of course is the conventional wisdom. The reality is that member commercial banks create new money every time they make loans to or buy securities from the non-bank public. On the basis of the "trading desk" adding $1 of "free gratis" legal reserves, the banking system acquires $200 in earning assets. Then the Fed recaptures most of the open market purchases earnings. Then 90% of those earnings are turned over to the Treasury. That procedure is extremely profitable for all of the participants. So what if they don't earn interest on their reserves.