The Wall Street Journal: Letter
“Fed Should Slowly Unwind Excess Reserves”
Before 2008, competition between banks forced them to loan out or otherwise invest excess reserves.
Sept. 26, 2018 3:15 p.m. ET
SEC chairman, Jay Clayton in April Photo: Yuri Gripas/Bloomberg News
Regarding your editorial “Sharing the Wealth of Markets” (Sept. 21): Yes, recent stock price increases aren’t creating new wealth as broadly as most would like because the market isn’t providing adequate liquidity for the kind of firms that drive economic growth. We believe that much of the blame rests with Federal Reserve policy.
The New Keynesian model the Fed uses led, in part, to paying banks interest on excess reserves in 2008. Before 2008 excess reserves were virtually zero but now hover near $2 trillion. This is no longer a rational response to the financial panic of 2008-09. Interest payments made by the Fed on those reserves have helped make major banks richer by not issuing loans from reserves but instead earning interest at no risk.
Before 2008, competition between banks forced them to loan out or otherwise invest excess reserves. This produced new economic activity that produced economic gains outside the banking sector. If the Fed began reducing the interest paid on excess reserves, the excess reserves would begin to enter the system and make capital available to startups by increasing liquidity.
If the near $2 trillion of excess reserves entered circulation tomorrow, it would soon expand the money stock, igniting a major inflation. Interest rates paid on excess reserves should therefore be cut in several stages. But if there ever was a compelling argument for paying banks to hold on to excess reserves, that time is past. The sooner the Fed unwinds this practice the sooner we can avoid frustrating the emergence and expansion of a new generation of wealth-creating firms.
Profs. Max Gillman and David C. Rose
University of Missouri-St. Louis