81.5% of Money Created through Quantitative Easing Is Sitting There Gathering Dust … Instead of Helping the Economy

Fed Has Been a Total Failure

Robert D. Auerbach – an economist with the U.S. House of Representatives Financial Services Committee for eleven years, assisting with oversight of the Federal Reserve, and now Professor of Public Affairs at the Lyndon B. Johnson School of Public Affairs at the University of Texas at Austin – notes today:

There is a massive misconception about where the Bernanke Fed’s stimulus landed. Although the Bernanke Fed has disbursed $2.284 trillion in new money (the monetary base) since August 1, 2008, one month before the 2008 financial crisis, 81.5 percent now sits idle as excess reserves in private banks. The banks are not required to hold excess reserves. The excess reserves exploded from $831 billion in August 2008 to $1.863 trillion on June 14, 2013. The excess reserves of the nation’s private banks had previously stayed at nearly zero since 1959 as seen on the St. Louis Fed’s chart. The banks did not leave money idle in excess reserves at zero interest because they were investing in income earning assets, including loans to consumers and businesses.

This 81.5 percent explosion in idle excess reserves means that the Bernanke Fed’s new money issues of $85 billion each month have never been a big stimulus. Approximately 81.5 percent (or $69.27 billion) is either bought by banks or deposited into banks where it sits idle as excess reserves. The rest of the $85 billion, approximately 18.5 percent (or $15.72 billion) continues to circulate or is held as required reserves on banks’ deposit accounts (unlike unrequired excess reserves).

What’s Professor Auerbach talking about?

We’ve repeatedly pointed out that the Federal Reserve has been intentionally discouraged banks from lending to Main Street – in a misguided attempt to curb inflation – which has increased unemployment and stalled out the economy.

We noted in 2010:

[T]he Fed has been paying the big banks high enough interest on the funds which they deposit at the Fed to discourage banks from making loans. Indeed, the Fed has explicitly stated that – in order to prevent inflation – it wants to ensure that the banks don’t loan out money into the economy, but instead deposit it at the Fed:

Why is M1 crashing? [the M1 money multiplier basically measures how much the money supply increases for each $1 increase in the monetary base, and it gives an indication of the "velocity" of money, i.e. how quickly money is circulating through the system]

Because the banks continue to build up their excess reserves, instead of lending out money:

(Click for full image)

These excess reserves, of course, are deposited at the Fed:

(Click for full image)

Why are banks building up their excess reserves?

As the Fed notes:

The Federal Reserve Banks pay interest on required reserve balances–balances held at Reserve Banks to satisfy reserve requirements–and on excess balances–balances held in excess of required reserve balances and contractual clearing balances.

The New York Fed itself said in a July 2009 staff report that the excess reserves are almost entirely due to Fed policy:

Since September 2008, the quantity of reserves in the U.S. banking system has grown dramatically, as shown in Figure 1.1 Prior to the onset of the financial crisis, required reserves were about $40 billion and excess reserves were roughly $1.5 billion. Excess reserves spiked to around $9 billion in August 2007, but then quickly returned to pre-crisis levels and remained there until the middle of September 2008. Following the collapse of Lehman Brothers, however, total reserves began to grow rapidly, climbing above $900 billion by January 2009. As the figure shows, almost all of the increase was in excess reserves. While required reserves rose from $44 billion to $60 billion over this period, this change was dwarfed by the large and unprecedented rise in excess reserves.

[Figure 1 is here]

Why are banks holding so many excess reserves? What do the data in Figure 1 tell us about current economic conditions and about bank lending behavior? Some observers claim that the large increase in excess reserves implies that many of the policies introduced by the Federal Reserve in response to the financial crisis have been ineffective. Rather than promoting the flow of credit to firms and households, it is argued, the data shown in Figure 1 indicate that the money lent to banks and other intermediaries by the Federal Reserve since September 2008 is simply sitting idle in banks’ reserve accounts. Edlin and Jaffee (2009), for example, identify the high level of excess reserves as either the “problem” behind the continuing credit crunch or “if not the problem, one heckuva symptom” (p.2). Commentators have asked why banks are choosing to hold so many reserves instead of lending them out, and some claim that inducing banks to lend their excess reserves is crucial for resolving the credit crisis.

This view has lead to proposals aimed at discouraging banks from holding excess reserves, such as placing a tax on excess reserves (Sumner, 2009) or setting a cap on the amount of excess reserves each bank is allowed to hold (Dasgupta, 2009). Mankiw (2009) discusses historical concerns about people hoarding money during times of financial stress and mentions proposals that were made to tax money holdings in order to encourage lending. He relates these historical episodes to the current situation by noting that “[w]ith banks now holding substantial excess reserves, [this historical] concern about cash hoarding suddenly seems very modern.”

[In fact, however,] the total level of reserves in the banking system is determined almost entirely by the actions of the central bank and is not affected by private banks’ lending decisions.

The liquidity facilities introduced by the Federal Reserve in response to the crisis have created a large quantity of reserves. While changes in bank lending behavior may lead to small changes in the level of required reserves, the vast majority of the newly-created reserves will end up being held as excess reserves almost no matter how banks react. In other words, the quantity of excess reserves depicted in Figure 1 reflects the size of the Federal Reserve’s policy initiatives, but says little or nothing about their effects on bank lending or on the economy more broadly.

This conclusion may seem strange, at first glance, to readers familiar with textbook presentations of the money multiplier.

Why Is The Fed Locking Up Excess Reserves?

Why is the Fed locking up excess reserves?

As Fed Vice Chairman Donald Kohn said in a speech on April 18, 2009:

We are paying interest on excess reserves, which we can use to help provide a floor for the federal funds rate, as it does for other central banks, even if declines in lending or open market operations are not sufficient to bring reserves down to the desired level.

Kohn said in a speech on January 3, 2010:

Because we can now pay interest on excess reserves, we can raise short-term interest rates even with an extraordinarily large volume of reserves in the banking system. Increasing the rate we offer to banks on deposits at the Federal Reserve will put upward pressure on all short-term interest rates.

As the Minneapolis Fed’s research consultant, V. V. Chari, wrote this month:

Currently, U.S. banks hold more than $1.1 trillion of reserves with the Federal Reserve System. To restrict excessive flow of reserves back into the economy, the Fed could increase the interest rate it pays on these reserves. Doing so would not only discourage banks from draining their reserve holdings, but would also exert upward pressure on broader market interest rates, since only rates higher than the overnight reserve rate would attract bank funds. In addition, paying interest on reserves is supported by economic theory as a means of reducing monetary inefficiencies, a concept referred to as “the Friedman rule.”

And the conclusion to the above-linked New York Fed article states:

We also discussed the importance of paying interest on reserves when the level of excess reserves is unusually high, as the Federal Reserve began to do in October 2008. Paying interest on reserves allows a central bank to maintain its influence over market interest rates independent of the quantity of reserves created by its liquidity facilities. The central bank can then let the size of these facilities be determined by conditions in the financial sector, while setting its target for the short-term interest rate based on macroeconomic conditions. This ability to separate monetary policy from the quantity of bank reserves is particularly important during the recovery from a financial crisis. If inflationary pressures begin to appear while the liquidity facilities are still in use, the central bank can use its interest-on-reserves policy to raise interest rates without necessarily removing all of the reserves created by the facilities.

As the NY Fed explains in more detail:

The central bank paid interest on reserves to prevent the increase in reserves from driving market interest rates below the level it deemed appropriate given macroeconomic conditions. In such a situation, the absence of a money-multiplier effect should be neither surprising nor troubling.

Is the large quantity of reserves inflationary?

Some observers have expressed concern that the large quantity of reserves will lead to an increase in the inflation rate unless the Federal Reserve acts to remove them quickly once the economy begins to recover. Meltzer (2009), for example, worries that “the enormous increase in bank reserves — caused by the Fed’s purchases of bonds and mortgages — will surely bring on severe inflation if allowed to remain.” Feldstein (2009) expresses similar concern that “when the economy begins to recover, these reserves can be converted into new loans and faster money growth” that will eventually prove inflationary. Under a traditional operational framework, where the central bank influences interest rates and the level of economic activity by changing the quantity of reserves, this concern would be well justified. Now that the Federal Reserve is paying interest on reserves, however, matters are different.

When the economy begins to recover, firms will have more profitable opportunities to invest, increasing their demands for bank loans. Consequently, banks will be presented with more lending opportunities that are profitable at the current level of interest rates. As banks lend more, new deposits will be created and the general level of economic activity will increase. Left unchecked, this growth in lending and economic activity may generate inflationary pressures. Under a traditional operating framework, where no interest is paid on reserves, the central bank must remove nearly all of the excess reserves from the banking system in order to arrest this process. Only by removing these excess reserves can the central bank limit banks’ willingness to lend to firms and households and cause short-term interest rates to rise.

Paying interest on reserves breaks this link between the quantity of reserves and banks’ willingness to lend. By raising the interest rate paid on reserves, the central bank can increase market interest rates and slow the growth of bank lending and economic activity without changing the quantity of reserves. In other words, paying interest on reserves allows the central bank to follow a path for short-term interest rates that is independent of the level of reserves. By choosing this path appropriately, the central bank can guard against inflationary pressures even if financial conditions lead it to maintain a high level of excess reserves.

This logic applies equally well when financial conditions are normal. A central bank may choose to maintain a high level of reserve balances in normal times because doing so offers some important advantages, particularly regarding the operation of the payments system. For example, when banks hold more reserves they tend to rely less on daylight credit from the central bank for payments purposes. They also tend to send payments earlier in the day, on average, which reduces the likelihood of a significant operational disruption or of gridlock in the payments system. To capture these benefits, a central bank may choose to create a high level of reserves as a part of its normal operations, again using the interest rate it pays on reserves to influence market interest rates.Because financial conditions are not “normal”, it appears that preventing inflation seems to be the Fed’s overriding purpose in creating conditions ensuring high levels of excess reserves.


As Barron’s notes:

The multiplier’s decline “corresponds so exactly to the expansion of the Fed’s balance sheet,” says Constance Hunter, economist at hedge-fund firm Galtere. “It hits at the core of the problem in a credit crisis. Until [the multiplier] expands, we can’t get sustainable growth of credit, jobs, consumption, housing. When the multiplier starts to go back up toward 1.8, then we know the psychological logjam has begun to break.”


It’s not just the Fed. The NY Fed report notes:

Most central banks now pay interest on reserves.

Auerbach explained in 2010:

Immediately after the recession took a dramatic dive in September 2008, the Bernanke Fed implemented a policy that continues to further damage the incentive for banks to lend to businesses. On October 6, 2008 the Fed’s Board of Governors, chaired by Ben Bernanke, announced it would begin paying interest on the reserve balances of the nation’s banks, major lenders to medium and small size businesses.

You don’t need a Ph.D. economist to know that if you pay banks ¼ percent risk free interest to hold reserves that they can obtain at near zero interest, that would be an incentive to hold the reserves. The Fed pumped out huge amounts of money, with the base of the money supply more than doubling from August 2008 to August 2010, reaching $1.99 trillion. Guess who has over half of this money parked in cold storage? The banks have $1.085 trillion on reserves drawing interest, The Fed records show they were paid $2.18 billion interest on these reserves in 2009.

A number of people spoke about the disincentive for bank lending embedded in this policy including Chairman Bernanke.


Jim McTague, Washington Editor of Barrons, wrote in his February 2, 2009 column, “Where’s the Stimulus:” “Increasing the supply of credit might help pump up spending, too. 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.”

Shortly after this article appeared Fed Chairman Bernanke explained: “Because banks should be unwilling to lend reserves at a rate lower than they can receive from the Fed, the interest rate the Fed pays on bank reserves should help to set a floor on the overnight interest rate.” (National Press Club, February 18, 2009) That was an admission that the Fed’s payment of interest on reserves did impair bank lending. Bernanke’s rationale for interest payments on reserves included preventing banks from lending at lower interest rates. That is illogical at a time when the Fed’s target interest rate for federal funds, the small market for interbank loans, was zero to a quarter of one percent. The banks would be unlikely to lend at negative rates of interest — paying people to take their money — even without the Fed paying the banks to hold reserves.

The next month William T. Gavin, an excellent economist at the St. Louis Federal Reserve, wrote in its MarchApril 2009 publication: “first, for the individual bank, the risk-free rate of ¼ percent must be the bank’s perception of its best investment opportunity.”

The Bernanke Fed’s policy was a repetition of what the Fed did in 1936 and 1937 which helped drive the country into a second depression. Why does Chairman Bernanke, who has studied the Great Depression of the 1930′s and has surely read the classic 1963 account of improper actions by the Fed on bank reserves described by Milton Friedman and Anna Schwartz, repeat the mistaken policy?

As the economy pulled out of the deep recession in 1936 the Fed Board thought the U.S. banks had too much excess reserves, so they began to raise the reserves banks were required to hold. In three steps from August 1936 to May 1937 they doubled the reserve requirements for the large banks (13 percent to 26 percent of checkable deposits) and the country banks (7 percent to 14 percent of checkable deposits).

Friedman and Schwartz ask: “why seek to immobilize reserves at that time?” The economy went back into a deep depression. The Bernanke Fed’s 2008 to 2010 policy also immobilizes the banking system’s reserves reducing the banks’ incentive to make loans.

This is a bad policy even if the banks approve. The correct policy now should be to slowly reduce the interest paid on bank reserves to zero and simultaneously maintain a moderate increase in the money supply by slowly raising the short term market interest rate targeted by the Fed. Keeping the short term target interest rate at zero causes many problems, not the least of which is allowing banks to borrow at a zero interest rate and sit on their reserves so they can receive billions in interest from the taxpayers via the Fed. Business loans from banks are vital to the nations’ recovery.

The fact that the Fed is suppressing lending and inflation at a time when it says it is trying to encourage both shows that the Fed is saying one thing and doing something else entirely.

Ellen Brown added some details in 2011:

Bruce Bartlett, writing in the Fiscal Times in July 2010, observed:

Economists are divided on why banks are not lending, but increasingly are focusing on a Fed policy of paying interest on reserves — a policy that began, interestingly enough, on October 9, 2008, at almost exactly the moment when the financial crisis became acute. . .

Historically, the Fed paid banks nothing on required reserves. This was like a tax equivalent to the interest rate banks could have earned if they had been allowed to lend such funds. But in 2006, the Fed requested permission to pay interest on reserves because it believes that it would help control the money supply should inflation reappear.

. . . [M]any economists believe that the Fed has unwittingly encouraged banks to sit on their cash and not lend it by paying interest on reserves.

At one time, banks collected deposits from their own customers and stored them for their own liquidity needs, using them to back loans and clear outgoing checks. But today banks typically borrow (or “buy”) liquidity, either from other banks, from the money market, or from the commercial paper market. The Fed’s payment of interest on reserves competes with all of these markets for ready-access short-term funds, creating a shortage of the liquidity that banks need to make loans.

By inhibiting interbank lending, the Fed appears to be creating a silent “liquidity squeeze” — the same sort of thing that brought on the banking crisis of September 2008. According to Jeff Hummel, associate professor of economics at San Jose State University, it could happen again.  He warns that paying interest on reserves “may eventually rank with the Fed’s doubling of reserve requirements in the 1930s and bringing on the recession of 1937 within the midst of the Great Depression.”

The bank bailout and the Federal Reserve’s two “quantitative easing” programs were supposedly intended to keep credit flowing to the local economy; but despite trillions of dollars thrown at Wall Street banks, these programs have succeeded only in producing mountains of “excess reserves” that are now sitting idle in Federal Reserve bank accounts.A stunning $1.6 trillion in excess reserves have accumulated since the collapse of Lehman Brothers on September 15, 2008.

The justification for TARP — the Trouble Asset Relief Program that subsidized the nation’s largest banks — was that it was necessary to unfreeze credit markets. The contention was that banks were refusing to lend to each other, cutting them off from the liquidity that was essential to the lending business.  But an MIT study reported in September 2010 showed that immediately after the Lehman collapse, the interbank lending markets were actually working.  They froze, not when Lehman died, but when the Fed started paying interest on excess reserves in October 2008. According to the study, as summarized in The Daily Bail:

. . . [T]he NY Fed’s own data show that interbank lending during the period from September to November did not “freeze,” collapse, melt down or anything else. In fact, every single day throughout this period, hundreds of billions were borrowed and paid back. The decline in daily interbank lending came only when the Fed ballooned its balance sheet and started paying interest on excess reserves.

Heck of a job, Bernanke …

Category: Think Tank

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

9 Responses to “81.5% of QE Money Is Not Helping the Economy”

  1. capitalistic says:

    The Fed is more about relatively low inflation and propping up asset values (i.e. wealth preservation). The Fed is trying to convince “risk takers” to take more risk (i.e. less leverage, more equity). Banks are in the business of lending, and it does no good for a bank to refuse lending, unless the underlying user of funds has a fundamentally sound business.

    One thing I never do is underestimate the intelligence of banks. They come in contact with main street daily. Fiscal policy has a more direct effect on main street compared to monetary policy.

  2. chartist says:

    The Japanese killing their currency is helping our economy more than the Fed. More Japanese manufacturing is coming to the US. Lexus recently announced they will build cars in Kentucky.

  3. Willy2 says:

    It’s a matter of psychology. In the good times banks want to lend, people want to borrow. But now people relaize they have borrowed too much, saved too little. And banks are afraid to lend, they know they’ve lend too much. And now the economists are baffled QE doesn’t work ?

  4. rich says:

    So the banks purchase new Treasuries from the US government by creating an offsetting liability (currency creation). Then the Fed buys these securities and places them on the Fed balance sheet. The cash the bank ends up with from this sale is left on the bank’s balance sheet. Beginning in Oct 2008, the Fed begins to pay them interest on this balance. This is a risk free transaction and the rate is currently .25%. Sort of a like a 12-b1 fee to the broker on a mutual fund sale. The current level of excess reserves now generate the industry a free $4.5 billion annually. Why would they lend?

    Sure reads like a ponzi scheme to me.

  5. DeDude says:

    The math and headline here is suspect and also reveal that there is a specific agenda. Banks excess reserves grew from 831 to 1863 that is 1032 in growth. As a % of the 2284 in new money that is 1032/2284 or 45% of the new money shuffles back as an increase in excess reserves. That does not make a nearly as impressive argument or headline, nor does it do nearly as well to peddle the story the author prefer. But that is the simple fact.

    The initial 831 came before QE and for other reasons than QE. An honest discussion of why, and if those reasons have dissipated, would have been nice. In a banking crisis the banks initially stop lending for fear, when that crisis develop into a severe recession they continue to hold back lending because there are not enough viable projects to fund. That is a much more likely explanation why so much money has stayed out of circulation. To think that a bank would prefer 0.25% from the Fed if they could get 6-8% from a good viable business proposal is patently absurd. If the banks were pushed to reduce their balances they would just throw that money back to the consumer (refusing or charging them for deposits). I have my doubts that QE is doing much good, but not from a phony calculation of where the money has “ended up”.

    Currently we are swimming in excess investment capital but have a huge lack in consumption (capacity utilization). Therefore, effects of any policy on economic growth are at this point exclusively judged by how it affects consumption.

    The argument for why reduced interest rates help the economy is that those in debt (irresponsible consumers) will spend less on interest and more on purchases. Furthermore, by pushing house prices up, more people can get out of their underwater mortgage traps (again mostly people who are “irresponsible consumers” and begin spending more as soon as they can). Lower rates for government also help counter the silly “austerity in a down economy” movement and thereby help the economy. Sustaining and inflating asset prices will also make more affluent people more secure and likely to spend a little more. However, on the negative effects list is the reduced income for all the regular folks who place their savings in safe things like FDIC insured CD’s, and use the interest income on consumption. I have not seen good quantitative numbers for the plus and minus side, but with house prices on the rise and government austerity losing steam, the plus side is getting smaller. My guess is that we are getting close to the point where low rates are doing more harm than good to consumption (= the economy).

  6. DTouche says:

    Capitalize and provide instant positive cashflow to the insolvent banking sector. In one swoop this solution allowed the derivative complex mutually assured destruction scenario to remain theoretical.

    Allowing the interbank lending to remain in effect would have allowed stronger banks to eliminate weaker banks and cash in on their derivative “insurance” and/or business if CDS payments failed. It seems like the interbank lending would have allowed JPM and Wells Fargo to completely dominate our banking sector by knocking off their competitors and taking their business, assets and credit default swap payments (if any money was left for CDS payments). The invention of derivatives was a great way to print money without crossing the Treasury Department.

    I am completely disgusted by this entire charade. Direct depositing $3T amongst 150 Million taxpayer bank accounts would have been the most direct and fair way to recapitalize banks and rapidly create consumer demand.

  7. ConscienceofaConservative says:

    Q.E. cannot create more lending. What the Fed does is buy one asset Treasuries from a bank and replaces it with cash(reserves). Since both sit on the same part of the balance sheet(assets) nothing about the bank has changed, and if the bank was constrained on the balance sheet before hand, that fact hasn’t changed. Even today after a big rise in bank stock prices lenders like BAC and Citi are still trading at huge discounts to book value. What Q.E. has done is make banks and everyone else switch to invest in higher risk assets(mortgages, high yield bonds, cdo’s) which raises asset prices.

  8. Herbert says:

    Did QE work at all?!? Oh yes, it did. It worked against bringing economic reforms.

  9. flow5 says:

    Article completely misses the economic repercussions. Lending & investing by the CBs is inflationary. But lending & investing by the NBs is non-inflationary (matching savings with investment). The lending capacity of the CBs is determined by monetary policy & not the savings practices of the public. The CBs could continue to lend even if the non-bank public ceased to save altogether.

    The IOeR policy allows the CBs to out bid the NBs for both loan-funds & collateral. I.e., virtually all the FRB-NY’s purchases were from the CBs (as evidenced by excess reserves growing pari passu with POMOs & not the money stock).

    The IOeR policy induces dis-intermediation within the NBs (where the size of the NBs have shrunk (-$6 billion), but the size of the CB system remains unaffected (+ $3.6 billion)). This is exactly the same paradigm as the 1966 S&L crisis. I.e., the CBs pay for what they already own (interest on their customer’s savings). But this is perverse as savings flowing through the NBs never leaves the CB system (as anybody who has applied double-entry bookkeeping on a national scale knows). The NBs are the CB’s customers.

    It is the NB’s outflow of funds, or negative cash flow, which forces the Fed to intervene & counteract the recessionary current in the economy.

    Whereas dis-intermediation for the CBs has not been predicated on interest rates since 1933, dis-intermediation for the NBs is almost exclusively dependent on the flow of voluntary savings placed at their disposal.

    Any time the Fed follows a contractionary monetary policy (where the rate-of-change in money flows is less than 2 percent relative to the roc in real-output), output can’t be sold, hiring will slow, & jobs will be lost (i.e., there is not sufficient upward & downward price flexibility within our domestic economy).

    What’s the real problem? E.g., both Vasco Curdia & Michael Woodford claim the CBs are intermediaries between savers & borrowers. Never are the CBs intermediaries in the savings-investment process. From a system’s viewpoint, commercial banks (DFIs), as contrasted to financial intermediaries (NBs): never loan out, & can’t loan out, existing deposits (saved or otherwise) including transaction deposits, or time deposits, or the owner’s equity, or any liability item.

    When CBs grant loans to, or purchase securities from, the non-bank public, they acquire title to earning assets by initially, the creation of an equal volume of new money- demand deposits – somewhere in the banking system. I.e., commercial bank deposits are the result of lending, not the other way around.

    I.e., the Friedman rule (http://www.nber.org/papers/w16208.pdf)

    & Keynes’s liquidity preference curve (demand for money) are both false doctrines.