–Nothing Apt To Be Done Anytime Soon With Old Monetary Tool
By Steven K. Beckner
(MNI) – The Federal Reserve’s ability to raise or lower bank
reserve requirements has been gathering dust in its monetary policy
toolchest for many years, and it’s likely to stay that way for the
Some have suggested the Fed raise reserve requirements to guard
against inflation, but that is highly improbable.
Indeed, reduction, or even elimination of reserve requirements is
There was a time when reserve requirements — the amount of cash or
reserves in Federal Reserve Bank accounts which depository institutions
must hold against a percentage of their deposits — were an important
part of the triad of monetary policy tools, along with the discount rate
and open market operations.
But it has become a largely moribund vestige of a bygone era in
monetary policymaking — useful only as a technical device for gauging
demand for reserves in the day-to-day pegging of the federal funds rate.
This is partially because financial institutions have become so
adept at getting around reserve requirements. To keep their reserves at
a minimum, banks regularly “sweep” money from deposits subject to
reserve requirements into deposits, such as money market accounts, that
are not subject to reserve requirements.
Not since 1992 has the Federal Reserve Board of Governors, which
has sole authority over reserve requirements, attempted to use them in
any meaningful way to affect financial conditions. At that time, with
the economy in the grips of a credit crunch, the Board reduced reserve
requirements on transaction accounts by two percentage points to 10%
above a certain minimum (currently $71 million).
There was some talk of possibly reducing them further to 8%, but
nothing came of it, and reserve requirements remain at 10%.
As part of the Financial Services Regulatory Relief Act of 2006,
Congress gave its approval for the Fed, as of October 2011, to pay
interest on both required reserves and on contractual clearing balances
and excess reserve balances which depository institutions hold
voluntarily at Reserve Banks.
As part of that legislation, Congress gave the Fed leeway to reduce
reserve requirements to zero if it so chooses.
Far from reducing reserve requirements, some have urged the Fed to
Columbia Business School professor Charles Calomiris, writing
recently in the Wall Street Journal, argued the Fed should raise reserve
requirements substantially as “an insurance policy against inflation.”
Calomiris, a member of the Shadow Open Market Committee, contended
the Fed has laid the foundation for a potential upsurge in inflation by
tripling excess reserves to $1.5 trillion. He cited the rebound in
commercial and industrial loans since the middle of last year to suggest
that those reserves are starting to leak into the economy to fuel
potential wage-price pressures.
Calomiris, who has presented papers at the Kansas City Fed’s annual
Jackson Hole symposium, argued that neither reverse repurchase
agreements nor increases in the rate of interest the Fed pays on excess
reserves is a reliable way of draining reserves and preventing them from
being converted, via bank loans, into inflationary increases in the
“Once lending starts looking profitable, the Fed might have to
raise its interest rate on reserves by a large amount to encourage banks
to retain those excess reserves,” he warned.
So Calomiris maintained “the only reliable way to prevent an
acceleration of inflation is to raise cash reserve requirements on bank
deposits by, say, half a trillion dollars” and pay interest on those
Since excess reserves are far above the minimum requirement, he
said raising reserve requirements “will have virtually no immediate
impact on credit availability in the economy” and that they “will not
pinch until loans and deposits get much higher.”
But there is no indication the Fed Board is likely to go in that
direction anytime soon.
Even when the time comes to exit from highly accommodative monetary
policy and tighten credit, raising reserve requirements has not been
part of the contingency planning.
When the Fed’s policymaking Federal Open Market Committee laid out
the likely progression of steps it would take to remove accommodation in
its minutes in each of the last two years, an increase in reserve
requirements was not mentioned.
On the contrary, when Fed officials have discussed reserve
requirements in recent years they have looked in the opposite direction.
Welcoming Congressional authorization of Fed payment of interest on
reserves in October 2006, Fed Chairman Ben Bernanke said, “By helping to
stabilize the demand for voluntary reserve balances, this authority may
allow the Federal Reserve to implement monetary policy without the need
for required reserve balances.”
“In these circumstances, the Board — as authorized by the act —
could consider reducing or even eliminating reserve requirements,
thereby reducing a regulatory burden for all depository institutions,”
There is no reason to believe that Fed officials’ predilection for
cutting, not raising, reserve requirements has changed.
Michael Feroli, chief U.S. economist for JPMorgan Chase, said
“regardless of what you think of the idea (of raising reserve
requirements) the odds of that happening are next to zero.”
“I don’t think that’s good policy,” said Feroli. “It goes counter
to the Fed’s long term policy of actually lowering reserve
requirements.” Cutting reserve requirements is “a more likely course of
Feroli said “going to zero reserve requirements wouldn’t be that
big a deal,” since “reserve requirements are rarely binding, given sweep
accounts,” but he said he would not expect the Fed to eliminate reserve
requirements until “calmer” financial conditions are restored.
Rather than use reserve requirements to curb lending, the Fed and
its fellow bank regulators have been more inclined to use capital
requirements and other supervisory tools.
“Harmonizing international capital ratios is the tool of choice,”
noted Feroli, adding, “if you start imposing (higher reserve
requirements) on U.S. banks you’d put them at a disadvantage.”
And anyway, there appears to be no sense of urgency about heading
off inflation. Although C&I loans grew by 9.6% last year, total loans
and leases grew just 1.7% as consumer and real estate lending
languished. In February the growth rates were 7.7% and 1.6%
And most Fed officials believe that, notwithstanding rising energy
costs, there is too much “slack” in the economy and inflation
expectations are too well anchored for inflation to take off.
New York Federal Reserve Bank President William Dudley focused more
on subpar economic growth and high unemployment Monday morning, while
predicting that both overall and core inflation will moderate in coming
Even if the Fed wanted to raise reserve requirements, it would not
be able to raise them nearly as much (a half trillion dollars) as
Calomiris proposed. There is a statutory ceiling of 14% on reserve
requirements on transaction accounts.
** MNI **