Everybody's Wrong About Money

Jeffrey Snider explains… nearly explains… tries to explain… what the heck Europe’s and America’s central banks have been up to since the start of the Great Recession and the Weensy Recovery:


One significant factor where I find myself in total agreement with the monetarists over at the FOMC is that “reserves” are meaningless in every context but the setting of monetary policy. This is not uncontroversial terrain, but it should be. Banking is not what most people think of it and in the modern “shadow” (wholesale is a better word, as is “eurodollar standard” for the global end of it) system there are far more important settings. The liability created by the Federal Reserve, titled “reserves”, is only a byproduct of whatever it is the Fed is trying to influence through the Open Market Desk.

That has not stopped nearly everyone from commenting on the status of reserves, especially as four successive episodes of QE followed ZIRP. At the outset, there was no end to hyperbole about how the rapid accumulation of reserves would unleash a torrent of “inflation.” Now on the other side, the conjecture has fallen to the opposite position.

So that’s where more traditional thinkers (myself included) have been wrong, at least so far. And I apologize for the lengthy excerpts, but we need even more to see the larger point:

One of the primary problems in the acute stages of panic (there were actually two phases to the panic; one began on August 9, 2007, and then flared again in September 2008 when the FOMC had already declared, as Ben Bernanke did publicly in June 2008, that the worst was behind) was the sudden and unintelligible (for orthodox economists) decline in the federal funds rate below, often significantly and durably, the Fed’s target. During the worst parts of the panic in autumn 2008, the federal funds effective rate not only fell far below target but remained there.

To answer that, the Fed began searching for ways to “drain” or “soak up” reserves. Such a task becomes even more paramount as the desperation “forces” the monetary agency down to the infamous monster of the zero lower bound (ZLB). There is not an orthodox central banker alive that does not, still, fret the ZLB. The ECB has crossed that rate Rubicon in June, and is now living with the whirlwind of having done so (it’s getting ugly).

The IOER was scheduled for launch in 2010, but was moved up to October 2008 in an attempt for the Fed to gain control of short-term interbank rates that were defying its target to the downside. By removing “excess liquidity” and locking it up at the Fed (by paying a small interest rate) the idea was that the private market for federal funds would see rates rise to where they “should” reside. They did not. This has remained a problem, spiking intermittently in the years since, throughout.

In the European version of monetary “plumbing”, the ECB offers a rate “corridor” of three primary levers. Without getting too far into the details, they essentially establish a ceiling, a midpoint and a floor by tailoring incentives and structures so that the private market “behaves.” Except that in Europe, too, the private market has not.


So the central bankers can’t get it right, either.

My takeaway from all this consists of nothing more than two small items:

• Not even the smartest people in banking can fix the bubbles and collapses created by Big Government’s perverse incentives — not even with unlimited funds and untrammeled (and largely unexamined) powers.

• Yet neither Big Government nor the Smartest People in Banking will ever give up on big government or central banking as solutions to everything.

Lather, fail, repeat.

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