Friday, 10 October 2008

How many times to you see a chart like this one?

It looks very odd doesn't it. So what exactly is this chart measuring?

First, we need to understand what are excess reserves. It is the amount of money that commercial banks give to the Fed in excess of required reserves. Normally, banks are required to keep some minimum balances at the Fed, which are understandably called required reserves. Or to put it more simply, excess reserves is the cash that banks give to the Fed for safe keeping when they can't think of anything else to do with it.

The chart goes all the way back to the great depression. As you can see, banks back then stored a lot of idle money with the Fed. That was because they didn't want to lend it to anyone because the economy was doing so badly.

We can also see the aftermath of 9-11, when excess reserves shot up for a short period. It then returned to more normal levels.

In September this year, the level of excess reserves exploded. It went from less than $2 billion in August to $60 billion. Presumably, banks preferred to park their cash in the Fed rather than risk it anywhere else.

These are strange days.


Nick von Mises said...

You've nailed the basic point, except these are reserves borrowed from the Fed itself.

Notice column two and it's change:

Just an elaborate bookingkeeping exercise reflecting the Fed trying to push new money into the economy and the banks just parking it.

Imagine what'll happen now the Fed is gonna PAY the banks interest on the holdings. Not pleasant for the real economy. And very deflationary.

mike said...

Incidentally the 7 billion added to UK reserve balances during September was (apparently) due to a finetune operation:

After asking the BOE the response was:

"Reserves balances are impacted by the level of aggregate reserves balances set voluntarily by reserves banks. These increased from 26800 to 27050 from the monthly maintenance period beginning 7 August to that starting on 4 September. The Bank also provided additional reserves during September in a number of fine tuning repo open market operations. These additional reserves are held in reserves banks balances."

I feel privileged that they even bothered to answer!