The New York Fed published a paper today on Precautionary Reserves and the Interbank Market which looks at the problem of banks hoarding the Federal funds provided them over the pas few months. In the paper they state:
"Our interest lies in studying the precautionary behavior of banks facing liquidity shocks and credit constraints, and how this affects the interbank market equilibrium. To achieve this, we develop a model with payment liquidity shocks, credit constraints and limited interbank market participation. Banks rationally hold large precautionary balances intra- day and overnight, which may be described as hoarding, and which leads to volatility in the interbank market rate. We show that extreme outcomes that occur during a crisis may be in part explained by our general model of interbank market frictions. The model also gives broad theoretical results about the effects of such interbank lending frictions during non-crisis times."
As we have shown in our previous entry the ratio of M2 to Federal Balance Sheet assets is usually 45:1 but the new ones due to hoarding are 15:1. This is bad news for many reasons. First the funds are now going out to the market for financing. Second, and this is more serious, when the banks loosen up, the M2 will explode and given the simple relationship between M2 and inflation we would anticipate a rate of inflation well in excess of 12-15% per annum, well above the 2-3% we see now. Thus the Feds attempt to stave off deflation will result in a strong potential for massive inflation.
Although this paper is quite analytical, it does show that there is concern.
The worst part, however, is the gross perceived incompetence of the Feds oversight as exemplifies in the presentation of their Inspector General to Congress. Chairman Bernake has a duty to provide transparency on this issue which seems to be lacking.
Further what I see is that the many economists seem to be missing this simple causal relationship between monetary policy and the attempts to drive liquidity in the system.
The question is; why are the banks hoarding. In my opinion it seems to be simple, fear of the current Administration taking over a bank which it in its sole opinion is not doing well, at least as they define it in the "stress test" analysis. The unintended consequence of the "stress tests" is the spreading of fear about the banks own balance sheets and the resulting hoarding of cash and in turn the resultant explosive impact of impending inflation!
The data is now clear and unfortunately no one is looking forward!
"Our interest lies in studying the precautionary behavior of banks facing liquidity shocks and credit constraints, and how this affects the interbank market equilibrium. To achieve this, we develop a model with payment liquidity shocks, credit constraints and limited interbank market participation. Banks rationally hold large precautionary balances intra- day and overnight, which may be described as hoarding, and which leads to volatility in the interbank market rate. We show that extreme outcomes that occur during a crisis may be in part explained by our general model of interbank market frictions. The model also gives broad theoretical results about the effects of such interbank lending frictions during non-crisis times."
As we have shown in our previous entry the ratio of M2 to Federal Balance Sheet assets is usually 45:1 but the new ones due to hoarding are 15:1. This is bad news for many reasons. First the funds are now going out to the market for financing. Second, and this is more serious, when the banks loosen up, the M2 will explode and given the simple relationship between M2 and inflation we would anticipate a rate of inflation well in excess of 12-15% per annum, well above the 2-3% we see now. Thus the Feds attempt to stave off deflation will result in a strong potential for massive inflation.
Although this paper is quite analytical, it does show that there is concern.
The worst part, however, is the gross perceived incompetence of the Feds oversight as exemplifies in the presentation of their Inspector General to Congress. Chairman Bernake has a duty to provide transparency on this issue which seems to be lacking.
Further what I see is that the many economists seem to be missing this simple causal relationship between monetary policy and the attempts to drive liquidity in the system.
The question is; why are the banks hoarding. In my opinion it seems to be simple, fear of the current Administration taking over a bank which it in its sole opinion is not doing well, at least as they define it in the "stress test" analysis. The unintended consequence of the "stress tests" is the spreading of fear about the banks own balance sheets and the resulting hoarding of cash and in turn the resultant explosive impact of impending inflation!
The data is now clear and unfortunately no one is looking forward!
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