New Study Explains Buildup of Reserves in U.S. Banking System As a By-Product of Fed's Liquidity Programs

Federal Reserve Bank of New York Number 4 2009 Resea rchUpdate Research and Statistics Group www.newyorkfed.org/research New Study Explains Buildup of Reserves in U.S. Banking System as a By-Product of Fed’s Liquidity Programs or some observers, the rapid growth bank’s vault or ATMs, that can be used of excess reserves in the U.S. bank - to meet the bank’s legal reserve require - Fing system during the financial crisis ment. Between September 2008 and the has been a troubling development—a sign end of 2009, reserves surged from about that banks are “hoarding” funds rather $45 billion to more than $900 billion. than lending them out and hence that the Excess reserves—the portion of reserves Federal Reserve’s efforts to restore the remaining after a bank has met its legal flow of credit to firms and households requirement—accounted for the bulk of have faltered. In “Why Are Banks the increase. Holding So Many Excess Reserves?” To explain this surge, Keister and (Current Issues in Economics and Finance , McAndrews present simple examples vol. 15, no. 8), authors Todd Keister and that show how the types of actions taken James McAndrews dispute this view. by central banks to ease liquidity strains Using a series of examples to illustrate during the financial crisis—loans to how reserves are created, they demon - banks and other firms as well as direct strate that the buildup of excess reserves purchases of assets—create large quanti - is simply a by-product of the lending ties of reserves. The level of reserves in facilities and asset purchase programs a country’s banking system, the authors established by the Federal Reserve during observe, is determined almost entirely by the financial crisis. The very high level of the central bank’s actions. By contrast, reserves, the authors con - the actions of individual banks will have tend, reflects the large scale of the Fed’s initia - Also in this issue… tives, but conveys no infor - mation about the lending Most downloaded publications . 2 behavior of banks. Staff Reports: New titles . 3 As the authors explain, Papers recently published by Research reserves are funds held by Group economists . 11 a bank, either as balances Papers presented at conferences . 11 on deposit at the Federal Publications and papers: October-December . 13 Reserve or as cash in the RVoelsuemarech9,UNpduamtbeerI 4N,u2m0b0e6r 4, 2009 no effect on aggregate reserves: As the In the final section of the article, authors’ examples show, an individual Keister and McAndrews discuss the bank can lower its reserves by lending importance of paying interest on them out or using them to purchase other reserves—as the Fed began to do in assets, but its actions simply transfer the October 2008—when the level of excess funds to other banks’ reserve accounts reserves is unusually high: “Paying inter - and do not alter the total level of reserves est on reserves allows a central bank to in the banking system. Thus, the current maintain its influence over market inter - high level of reserves in the U.S. banking est rates irrespective of the quantity of system reflects the scale of the Federal reserves in the banking system. The cen - Reserve’s recent policy initiatives and tral bank can then scale its policy initiatives cannot be interpreted as evidence that according to conditions in the financial banks are stockpiling funds rather than sector, while setting its target for the 2 lending them out. short-term interest rate in response to macroeconomic conditions.” I Most Downloaded Publications Listed below are the most sought after SSRN website, 2009: Research Group articles and papers from I “Understanding the Securitization of the New York Fed’s website and from the Subprime Mortgage Credit,” by Adam Bank’s page on the Social Science B. Ashcraft and Til Schuermann ( Staff Research Network site (www.ssrn.com/link/ Reports , no. 318, March 2008) – FRB-New-York.html ). 8,316 downloads New York Fed website, 2009: I “The Consolidation of the Financial I “Understanding the Securitization of Services Industry: Causes, Consequences, Subprime Mortgage Credit,” by Adam and Implications for the Future,” Allen B. Ashcraft and Til Schuermann ( Staff N. Berger, Rebecca S. Demsetz, and Reports , no. 318, March 2008) – Philip E. Strahan ( Staff Reports , no. 55, 12,769 downloads December 1998) – 2,524 downloads I “The Yield Curve as a Predictor of I “An Empirical Analysis of Stock U.S. Recessions,” by Arturo Estrella and Bond Market Liquidity,” Tarun and Frederic S. Mishkin ( Current Chordia, Asani Sarkar, and Avanidhar Issues in Economics and Finance , vol. 2, Subrahmanyam ( Staff Reports , no. 164, no. 7, June 1996) – 10,002 downloads March 2003) – 1,933 downloads I “Why Are Banks Holding So Many For lists of the top-ten downloads, Excess Reserves?” by Todd Keister visit www.newyorkfed.org/research/ and James McAndrews ( Staff Reports , top_downloaded/index.html . no. 380, July 2009) – 8,749 downloads Federal Reserve Bank of New York www.newyorkfed.org/research New Titles in the Staff the Federal Reserve Act to cushion the strains on financial intermediaries’ balance Reports Series sheets and thereby target the unusually wide spreads in various credit markets. The following new staff reports are avail - While classic monetary policy targets a able at price—for example, the federal funds rate— www.newyorkfed.org/research/staff_reports . the liquidity facilities affect balance sheet quantities. The financial crisis forcefully MACROECONOMICS demonstrated that the collapse of the AND GROWTH financial sector’s balance sheet capacity can have powerful adverse effects on the No. 396, October 2009 real economy. This study reexamines the Prices and Quantities in the Monetary distinctions between prices and quantities Policy Transmission Mechanism in monetary policy transmission. Tobias Adrian and Hyun Song Shin Central banks have various tools for imple - No. 397, October 2009 3 menting monetary policy, but the tool Monetary Tightening Cycles and receiving the most attention in the litera - the Predictability of Economic Activity Arturo Estrella and Tobias Adrian ture has been the overnight interest rate. The financial crisis that erupted in the Eleven of fourteen monetary tightening summer of 2007 has refocused attention on cycles since 1955 were followed by increases other channels of monetary policy, notably in unemployment; three were not. The the transmission of policy through the sup - term spread at the end of these cycles ply of credit and overall conditions in the discriminates almost perfectly between capital markets. In 2008, the Federal subsequent outcomes, but levels of nominal Reserve put into place various lender-of- or real interest rates, as well as other last-resort programs under section 13(3) of interest rate spreads, generally do not. Publications and Papers The Research and Statistics Group produces a wide range of publications: I The Economic Policy Review —a policy-oriented journal focusing on economic and financial market issues. I EPR Executive Summaries —online versions of selected Economic Policy Review articles, in abridged form. I Current Issues in Economics and Finance —concise studies of topical economic and financial issues. I Second District Highlights —a regional supplement to Current Issues . I Staff Reports —technical papers intended for publication in leading economic and finance journals, available only online. I Publications and Other Research —an annual catalogue of our research output. Research and Statistics Group Research Update I Number 4, 2009 No. 398, October 2009 characteristics of U.S. labor market data. Financial Intermediaries and First, individual consumption is affected by Monetary Economics the number of hours worked: Employed Tobias Adrian and Hyun Song Shin agents consume more on average than the This study reconsiders the role of financial unemployed do. Second, changes in the intermediaries in monetary economics. employment rate, a central factor explain - Adrian and Shin explore the hypothesis ing variation in total hours, affect aggregate that financial intermediaries drive the busi - consumption. Demand shocks—such as ness cycle by way of their role in determin - shifts in the marginal efficiency of investment ing the price of risk. In this framework, as well as government spending shocks and balance sheet quantities emerge as a key news shocks—are shown to generate eco - indicator of risk appetite and hence of the nomic fluctuations consistent with observed “risk-taking channel” of monetary policy. business cycles. The authors document evidence that the balance sheets of financial intermediaries No. 404, November 2009 4 reflect the transmission of monetary policy Conventional and Unconventional through capital market conditions. They Monetary Policy find short-term interest rates to be impor - Vasco Cúrdia and Michael Woodford tant in influencing the size of financial Cúrdia and Woodford extend a standard intermediary balance sheets. The findings New Keynesian model both to incorporate suggest that the traditional focus on the heterogeneity in spending opportunities money stock for the conduct of monetary along with two sources of (potentially time- policy may have more modern counter - varying) credit spreads and to allow a role parts, and point to the importance of track - for the central bank’s balance sheet in ing balance sheet quantities for the con - determining equilibrium. They use the duct of monetary policy. model to investigate the implications of imperfect financial intermediation for No. 399, October 2009 familiar monetary policy prescriptions and Labor Supply Heterogeneity and to consider additional dimensions of cen - Macroeconomic Comovement tral bank policy—variations in the size and Stefano Eusepi and Bruce Preston composition of the central bank’s balance Standard real business cycle models must sheet as well as payment of interest on rely on total factor productivity (TFP) reserves—alongside the traditional question shocks to explain the observed comove - of the proper operating target for an ment of consumption, investment, and overnight policy rate.

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