–Nothing Apt To Be Done Anytime Soon With Old Monetary Tool

By Steven K. Beckner

(MNI) – The Federal Reserve’s ability to raise or lower bank

reserve requirements has been gathering dust in its monetary policy

toolchest for many years, and it’s likely to stay that way for the

foreseeable future.

Some have suggested the Fed raise reserve requirements to guard

against inflation, but that is highly improbable.

Indeed, reduction, or even elimination of reserve requirements is

more likely.

There was a time when reserve requirements — the amount of cash or

reserves in Federal Reserve Bank accounts which depository institutions

must hold against a percentage of their deposits — were an important

part of the triad of monetary policy tools, along with the discount rate

and open market operations.

But it has become a largely moribund vestige of a bygone era in

monetary policymaking — useful only as a technical device for gauging

demand for reserves in the day-to-day pegging of the federal funds rate.

This is partially because financial institutions have become so

adept at getting around reserve requirements. To keep their reserves at

a minimum, banks regularly “sweep” money from deposits subject to

reserve requirements into deposits, such as money market accounts, that

are not subject to reserve requirements.

Not since 1992 has the Federal Reserve Board of Governors, which

has sole authority over reserve requirements, attempted to use them in

any meaningful way to affect financial conditions. At that time, with

the economy in the grips of a credit crunch, the Board reduced reserve

requirements on transaction accounts by two percentage points to 10%

above a certain minimum (currently $71 million).

There was some talk of possibly reducing them further to 8%, but

nothing came of it, and reserve requirements remain at 10%.

As part of the Financial Services Regulatory Relief Act of 2006,

Congress gave its approval for the Fed, as of October 2011, to pay

interest on both required reserves and on contractual clearing balances

and excess reserve balances which depository institutions hold

voluntarily at Reserve Banks.

As part of that legislation, Congress gave the Fed leeway to reduce

reserve requirements to zero if it so chooses.

Far from reducing reserve requirements, some have urged the Fed to

raise them.

Columbia Business School professor Charles Calomiris, writing

recently in the Wall Street Journal, argued the Fed should raise reserve

requirements substantially as “an insurance policy against inflation.”

Calomiris, a member of the Shadow Open Market Committee, contended

the Fed has laid the foundation for a potential upsurge in inflation by

tripling excess reserves to $1.5 trillion. He cited the rebound in

commercial and industrial loans since the middle of last year to suggest

that those reserves are starting to leak into the economy to fuel

potential wage-price pressures.

Calomiris, who has presented papers at the Kansas City Fed’s annual

Jackson Hole symposium, argued that neither reverse repurchase

agreements nor increases in the rate of interest the Fed pays on excess

reserves is a reliable way of draining reserves and preventing them from

being converted, via bank loans, into inflationary increases in the

money supply.

“Once lending starts looking profitable, the Fed might have to

raise its interest rate on reserves by a large amount to encourage banks

to retain those excess reserves,” he warned.

So Calomiris maintained “the only reliable way to prevent an

acceleration of inflation is to raise cash reserve requirements on bank

deposits by, say, half a trillion dollars” and pay interest on those

additional reserves.

Since excess reserves are far above the minimum requirement, he

said raising reserve requirements “will have virtually no immediate

impact on credit availability in the economy” and that they “will not

pinch until loans and deposits get much higher.”

But there is no indication the Fed Board is likely to go in that

direction anytime soon.

Even when the time comes to exit from highly accommodative monetary

policy and tighten credit, raising reserve requirements has not been

part of the contingency planning.

When the Fed’s policymaking Federal Open Market Committee laid out

the likely progression of steps it would take to remove accommodation in

its minutes in each of the last two years, an increase in reserve

requirements was not mentioned.

On the contrary, when Fed officials have discussed reserve

requirements in recent years they have looked in the opposite direction.

Welcoming Congressional authorization of Fed payment of interest on

reserves in October 2006, Fed Chairman Ben Bernanke said, “By helping to

stabilize the demand for voluntary reserve balances, this authority may

allow the Federal Reserve to implement monetary policy without the need

for required reserve balances.”

“In these circumstances, the Board — as authorized by the act —

could consider reducing or even eliminating reserve requirements,

thereby reducing a regulatory burden for all depository institutions,”

Bernanke added.

There is no reason to believe that Fed officials’ predilection for

cutting, not raising, reserve requirements has changed.

Michael Feroli, chief U.S. economist for JPMorgan Chase, said

“regardless of what you think of the idea (of raising reserve

requirements) the odds of that happening are next to zero.”

“I don’t think that’s good policy,” said Feroli. “It goes counter

to the Fed’s long term policy of actually lowering reserve

requirements.” Cutting reserve requirements is “a more likely course of

action.”

Feroli said “going to zero reserve requirements wouldn’t be that

big a deal,” since “reserve requirements are rarely binding, given sweep

accounts,” but he said he would not expect the Fed to eliminate reserve

requirements until “calmer” financial conditions are restored.

Rather than use reserve requirements to curb lending, the Fed and

its fellow bank regulators have been more inclined to use capital

requirements and other supervisory tools.

“Harmonizing international capital ratios is the tool of choice,”

noted Feroli, adding, “if you start imposing (higher reserve

requirements) on U.S. banks you’d put them at a disadvantage.”

And anyway, there appears to be no sense of urgency about heading

off inflation. Although C&I loans grew by 9.6% last year, total loans

and leases grew just 1.7% as consumer and real estate lending

languished. In February the growth rates were 7.7% and 1.6%

respectively.

And most Fed officials believe that, notwithstanding rising energy

costs, there is too much “slack” in the economy and inflation

expectations are too well anchored for inflation to take off.

New York Federal Reserve Bank President William Dudley focused more

on subpar economic growth and high unemployment Monday morning, while

predicting that both overall and core inflation will moderate in coming

months.

Even if the Fed wanted to raise reserve requirements, it would not

be able to raise them nearly as much (a half trillion dollars) as

Calomiris proposed. There is a statutory ceiling of 14% on reserve

requirements on transaction accounts.

** MNI **

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