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August 28, 2012

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Posted: 28 Aug 2012 12:33 AM PDT
I couldn't resist commenting on the economic policies being promoted at the Republican National Convention:
Republicans: We Won't Build That
(The discussion of Republican policy is at the end of the article.)
Posted: 28 Aug 2012 12:06 AM PDT
Posted: 27 Aug 2012 01:56 PM PDT
Ezra Klein notes that Republicans aren't the deficit hawks they claim to be:
Remembering the Republicans' stimulus, by Ezra Klein: I see that the Republican convention will feature a debt clock ticking away behind the speakers. It will also, as I understand it, consist entirely of speakers who want to make all the Bush tax cuts permanent without paying for them, and who want to pass trillions of dollars more in tax cuts that they also haven't said how they'll pay for.

...The Senate Republicans ... voted for Sen. Jim DeMint's "American Option: A Jobs Plan That Works." DeMint's plan would have extended all of the Bush tax cuts permanently, cut the top marginal rate from 35 percent to 25 percent, the corporate rate from 35 percent to 25 percent and the estate tax to almost nothing.
The proposal would have cost about $3 trillion over the next decade — so a bit less than 400 percent what the stimulus cost — ...not a dollar of it would've been paid for..., and the tax cuts were largest for the richest Americans... Yet most every Senate Republican voted for it. And now they're standing on the stage underneath a debt clock arguing that the Obama administration spent too much. ...
 But both Romney's and Ryan's budgets include a tax reform that looks very much like what DeMint proposed...
Posted: 27 Aug 2012 09:58 AM PDT
An interview with Thomas Kochan, the Bunker professor of management, MIT's Sloan School of Management, and co-director of the MIT Institute for Work and Employment Research:
Can America Compete?, Harvard Magazine: ...Read the complete article, "Can America Compete?" (September-October 2012)
Harvard Magazine: You speak of a fundamental human-capital paradox in the way American employers and workers interact with each other.
Thomas Kochan: American corporations often say human resources are their most important asset. In our national discourse, everyone talks about jobs. Yet as a society we somehow tolerate persistent high unemployment, 30 years of stagnating wages and growing wage inequality, two decades of declining job satisfaction and loss of pension and retirement benefits, and continuous challenges from the consequences of unemployment on family life. If we really valued work and human resources, we would address these problems with the vigor required to solve them.
HM: What causes this disconnection?
TK: The root cause is that we have become a financially driven economy. The view of shareholder value as corporations' primary objective has dominated since the 1980s. That motivation—to get short-term shareholder returns—then pushes to lower priority all the other things we used to think about as a social contract: that wages and productivity should go together, that there should be an alignment between the interest of American business and the overall American economy and society. That creates a market failure: it's not in the interest of an individual firm to address all of the consequences of unemployment and loss of high-quality jobs, but the business community overall depends on high-quality jobs to produce the purchasing power needed to sell their goods and services to the American market. Sixty percent of U.S.-based multinational corporations' revenue still comes from the U.S. market. We've got to solve this market failure.
But I think there is also a deep institutional failure in the United States. We have allowed the labor movement and the government and our educational institutions—the coordinating glue that brought these different interests together and provided some assistance in coordinating economic activity—all to decline in effectiveness. Government is completely polarized and almost impotent at the moment. Unions have declined to the point where they are no longer able to discipline management or serve as a powerful and valued partner with business to solve problems. And I'm concerned that our business schools particularly have receded into the same myopic view of the economic system where finance rules everything, so we aren't training the next generation of leaders to manage businesses in ways that work for both investors and shareholders and for employees in the community. ...
Posted: 27 Aug 2012 09:31 AM PDT
Many people have called for the Fed to lower the rate it pays on reserves as a way of stimulating loan activity -- the argument is that if the reward to holding funds is lowered then banks are more likely to let go of them -- but Gaetano Antinolfi and Todd Keister of the NY Fed argue that lowering the rate would not have much of an effect on bank lending:
Interest on Excess Reserves and Cash "Parked" at the Fed, by Gaetano Antinolfi and Todd Keister, Liberty Sreet, FRB NY: The European Central Bank recently lowered from 0.25 percent to zero the interest rate it pays on funds that Eurozone banks hold on deposit with it. On the same day, Denmark's central bank began charging banks 0.20 percent (that is, paying a negative interest rate) on certain deposits. These events have led commentators to ask what would happen if the Federal Reserve were to reduce the interest rate that banks in the United States earn on funds in their reserve accounts from its current level of 0.25 percent. In particular, some people wonder if lowering this rate would lead banks to hold smaller deposits at the Fed and instead lend out some of these "idle" balances. In this post, we use the structure of the Fed's balance sheet to illustrate why lowering the interest rate paid on reserve balances to zero would have no meaningful effect on the quantity of balances that banks hold on deposit at the Fed.
Since 2008, the amount of money banks hold on deposit at the Federal Reserve has increased dramatically, as shown in the chart below. The vast majority of these funds represent excess reserves, that is, funds held above the level needed to meet an institution's reserve requirement. (See this Federal Reserve Bank of Richmond paper for a more detailed view.) Some observers have called for the Fed to lower the interest rate it pays on excess reserves (often called the IOER rate) as a way of encouraging banks to maintain lower balances.
Deposits-Held-by-Banks-at-the-Federal-Reserve
The View from the Balance Sheet
It's important to keep in mind, however, what determines the total quantity of these balances. One way of understanding the issue is by looking at the Fed's balance sheet, a simple version of which is presented in the table below.
Balance-Sheet-of-the-Federal-Reserve-System-August-1-2012

As the table shows, the balances that banks hold on deposit at the Fed are liabilities of the Federal Reserve System. The other significant liability is currency in the form of Federal Reserve notes. Together, this currency and these deposits make up the monetary base, the most basic measure of the money supply in the economy. The composition of the monetary base between these two elements is determined largely by the amount of currency used by firms and households (both in the United States and abroad) to make transactions and by banks to stock their ATM networks.
What determines the size of the monetary base? As with any other institution's balance sheet, the Fed's dictates that its liabilities (plus capital) equal its assets. The Fed's assets are predominantly Treasury and mortgage-backed securities, most of which have been acquired as part of the large-scale asset purchase programs. In other words, the size of the monetary base is determined by the amount of assets held by the Fed, which is decided by the Federal Open Market Committee as part of its monetary policy.
It's now becoming clear where our story's going. Because lowering the interest rate paid on reserves wouldn't change the quantity of assets held by the Fed, it must not change the total size of the monetary base either. Moreover, lowering this interest rate to zero (or even slightly below zero) is unlikely to induce banks, firms, or households to start holding large quantities of currency. It follows, therefore, that lowering the interest rate paid on excess reserves will not have any meaningful effect on the quantity of balances banks hold on deposit at the Fed.
Language Matters
The language used in the press and elsewhere is often imprecise on this point and a source of potential confusion. Reserve balances that are in excess of requirements are frequently referred to as "idle" cash that banks choose to keep "parked" at the Fed. These comments are sensible at the level of an individual bank, which can clearly choose how much money to keep in its reserve account based on available lending opportunities and other factors. However, the logic above demonstrates that the total quantity of reserve balances doesn't depend on these individual decisions. How can it be that what's true for each individual bank is not true for the banking system as a whole?
The resolution to this apparent puzzle is that when one bank decides to hold a lower balance in its reserve account, the funds it sheds necessarily end up in the account of another bank, leaving the total unchanged (see FT Alphaville and this New York Fed Current Issues in Economics and Finance article for more detailed discussions of this point). In the aggregate, therefore, these balances do not represent "idle" funds that the banking system is unwilling to lend. In fact, the total quantity of reserve balances held by banks conveys no information about their lending activities – it simply reflects the Federal Reserve's decisions on how many assets to acquire.
Other Implications
This logic doesn't imply that changing the IOER rate would have no effect on banks' lending decisions, of course. A change in this rate could feed through to changes in other interest rates in the economy and thereby potentially affect the incentives for banks to lend and for firms and households to borrow. Lowering this rate may also lead to disruptions in markets that weren't designed to operate at very low interest rates (see this earlier post for a discussion). Households and firms could respond to these changes in ways that either increase or decrease the amount of currency in circulation, the level of bank deposits, required reserves, and other variables. These shifts would likely be small, however, and should not obscure the basic point: The quantity of balances banks hold on deposit at the Fed would be essentially unaffected by a change in the IOER rate.
A final note: If the IOER rate were set sufficiently far below zero, banks may choose to store currency rather than hold deposits at the Fed, and households may prefer holding cash if banks impose significant fees on deposits. In this case, the level of reserve balances would decline, but the change would simply reflect a shift in the composition of the monetary base; its total size would remain unchanged for the reasons described above.

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