I was intrigued by this passage, from Interfluidity:
Interest rates are, for the moment, excruciatingly low. But a subsidy
to the banking system, once put into place, will be quite hard to
dislodge. So, let’s imagine that the Fed will pay interest on bank
reserves in perpetuity, that it will pay such interest at or near the
risk-free short-term interest rate, and that the expansion of the Fed’s
balance sheet is more or less permanent. How large a subsidy to the
banking system do the interest payments on reserves represent? Some
problems are arithmetically challenging, but not this one. The present
value of a perpetual stream of market-rate interest payments is
precisely the amount of the principal. Therefore, the present value of
the Fed’s de facto commitment to pay interest to banks on $800B
of freshly created reserves is $800B. We fought and wailed and gnashed
our teeth over potentially overpaying for TARP assets. Meanwhile, we
are quietly allowing the Fed give away, as a direct, literal subsidy,
more than the entire $700B that Paulson was allowed to play with. Note
there is no question about this being an "investment": The interest
payments that the Fed is now making to banks on its suddenly expanded
balance sheet are not loans. The banks owe taxpayers absolutely nothing
in return for this windfall.
I take that calculation to be a very rough one, and possibly an overstatement, but the point remains of interest. It also can be argued that interest on reserves is a bad signal for at least two reasons:
1. It signals the Fed fears being left holding the intra-day Fedwire bag if a major bank goes under, and
2. It signals the Fed thinks major banks need such a subsidy.
The cited post is interesting throughout.
It is a great post at interfluidity.
On topic, the NPV of that amount of money might be = to the total amount, but it is doled out over infinity, so in more practical terms, it is far less than the huge number SW says. But still, his point about it was never their money so why give ‘em interest is well taken.
Slightly off topic:
He gets closer to the issue about fiat/electronic money than most – that we can do whatever the hell we want with these numbers in our computers to make people do what we want them to do. Negative interest rates are possible with electronic money. The market is demanding them, why not give them what they want?
Totally off topic, but related to our Keynes discussions:
The post before is even better. How can there be overcapacity? A funny question.
I would argue that is a tax reduction, rather.
I was going to ask the same question as Andy. According to the Fed website, “The interest rates on required reserve balances and excess balances for the reserve maintenance periods ending December 17, 2008 were calculated using the upper bound of the target range of 0 to 0.25 percent established by the FOMC on December 16, 2008.”
http://www.federalreserve.gov/monetarypolicy/reqresbalances.htm
I assume in plain English this means the Fed will pay 0.25% on required and excess reserve balances until there is another change in the Fed funds target, but I could be wrong. Needless to say, if this is accurate, I can’t see how this won’t screw with the markets: if a bank can earn 0.25% keeping reserves with the Fed and less than that if it lends to another bank through the Fed funds market, who would do the latter aside from Fannie and Freddie which apparently still don’t earn interest on reserves.
Great post!
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“…but the point remains of interest”. I had to read this line six times to fully appreciate its awesomeness.
If the interest rate is zero, you can’t calculate present value at all. That’s a clue that the calculation of present value has turned into noise when the interest rate is small.
A penny a year doesn’t imply a present value in the hundreds of billions, for example.
The underlying real world fact is that the time preference of money isn’t reflected by interest rates any longer; without which present value mathematically doesn’t have any meaning.
But a subsidy to the banking system, once put into place, will be quite hard to dislodge.
Oh, don’t worry, it will be very easy to dislodge. With bankruptcy comes all manner of dislodgements. (Is that a word?)
Strap on your helmets and put on your seatbelts. It’s time for a wild combination of quantitative easing followed by Keynesian money explosions.
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