Friday, January 6, 2012

Monetaray Policy in 2011: Looking Back

Total reserves in the banking system rose by almost 50 percent in 2011 to average around $1.6 trillion.  The increase during the year was slightly more than $511 billion. (Remember in August 2008 when total reserves in the banking system averaged less than $45 billion?)

Excess reserves in the banking system rose by about $490 billion from December 2010 to December 2011 to a total of about $1.5 trillion. (Remember in August 2008 when excess reserves in the banking system averaged less than $2 billion?)

The Federal Reserve continued to pump reserves into the banking system in 2011 and about 95% of the reserves going into the banking system went into excess reserves. 

Bank loans fell during the year by approximately $50 billion.  There was a pickup in business loans (commercial and industrial loans) of about $122 billion, but real estate loans (primarily commercial real estate loans) fell by $150 billion and consumer loans dropped by $22 billion. 

Note that the pickup in business loans was predominately located in the largest 25 domestically chartered banks in the United States.  The increase here was approximately $95 billion. 

One can conclude from this that the reserves that the Fed pumped into the banking system did not, on balance, go to support an increase in lending.

Yet, the growth rate in both measures of the money stock rose during the year.  For the M1 measure of the money stock, the year-over-year rate of increase rose from 7.5 percent in December 2010 to 19.1 percent in December 2011. (This is using the 13-week average of the measure.)  The year-over-year rate of growth of the M2 measure of the money stock rose from 3.3 percent in December 2010 to 9.8 percent in December 2011. (Again using the 13-week average.)

The increase was highlighted by a whopping 45% rise in demand deposits!

But, this increase in demand deposits did not come from an increase in bank lending because the bank lending that might have resulted in an increase in demand deposits and hence the M1 money stock actually declined!

The reason for the huge increase in demand deposits seems to be that people are moving assets from short-term investment vehicles to demand deposit accounts. 

For the past two years or so I have been arguing that this movement into demand deposits is coming for two reasons.  The first reason is that interest rates on short term investments are so low that people do not believe that it is worthwhile to keep their money in interest bearing assets rather than demand deposits. (For example, Federal Reserve data record a drop of almost $90 billion in Institutional Money Funds over the past year.)

The second reason is that many people are still is difficult financial condition.  Hence, they are keeping what funds they have in transaction-type accounts so as to pay for necessary living expenses.  Additional information that supports this argument is that the currency component of the money stock rose by more than 9 percent this last year.  This is, historically, an extremely high number.  People in tough economic situations also hold more cash.

The evidence from the banking system is not very encouraging with regards to a pickup in economic activity.

How did the Federal Reserve inject more than $500 billion reserves into the banking system this last year?

First, the Federal Reserve increased its holdings of securities by roughly $442 billion.  Actual acquisitions of Treasury securities amounted to about $640 billion but these purchases were offset by a $43 billion decrease in the Fed’s holdings of Federal Agency issues and a $154 decline in the Fed’s holdings of mortgage backed securities. 

One should also note that there was a net decrease in funds associated with the bailout actions of 2007 and 2008 of approximately $140 billion. Also, primary borrowings from the Fed’s discount window declined by $36 billion.  One generally assumes that these “operating” factors are offset by the Fed’s purchase of securities.  Thus the “net” addition of funds from the increase in the Fed’s outright holdings of securities totaled about $266 billion. 

Second, the United States Treasury also played a role in the increase in bank reserves.  At the end of 2010, the Treasury held almost $200 billion in something called the U. S. Treasury Supplementary Financing Account. (I have mentioned the use of this account many times in 2010…here is one post: These funds were injected into the banking system this past year…the full $200 billion of them.  This can be added to the $376 billion mentioned in the previous paragraph to account for $466 billion of reserves going into the banking system. 

Third, the currency being demanded by the public mentioned above is supplied to the public by the Federal Reserve “on demand”.  That is, the Federal Reserve generally replaces the currency flowing out of the banking system into general circulation, dollar for dollar.  This past year, currency in circulation rose by about $93 billion.  Thus the $466 billion of the previous paragraph drops to $373 billion.

Fourth, the Federal Reserve has “pumped” dollars into the European banking system due to the sovereign debt crisis in Europe.  For example, Central bank liquidity swaps have increased by about $100 over the past year, most of the increase coming in the past six months.  This is not the only way the Fed influences what is going on internationally as the Fed holds other assets denominated in foreign currencies and also engages in reverse repurchase agreements with “foreign official and international accounts”.  If one roughly nets out the accounts associated with all of these type of transactions, we can say that the Fed roughly added another $104 billion to bank reserves which brings the total injection to $477 billion 

One final operating factor influences this total figure, payments into and out to the general account of the United States Treasury.  This fluctuates with tax payments and actual government expenditures.  The year-over-year drop in this account is about $28 billion and this brings the total increase in “reserve balances at Federal Reserve banks to $505 billion, which matches very closely with the $490 increase in excess reserves mentioned in the second paragraph of this post. (The difference is due to minor operating factors that we do not need to discuss.)

In summary, the Federal Reserve (and the U. S. Treasury) put a lot of reserves into the banking system this past year.  As usual, the Fed needs to take care of other operating factors that constantly impact the banking system, but in general, the injection of reserves came from the securities the Fed purchased as a part of the QE2, the dollars being advanced to European central banks to help relieve the pressures of the sovereign debt crisis, and the injection of funds into the banking system from the fiscal activities of the United States Treasury.

As of this time, the reserves going into the banking system have not been lent out…they are just sitting on the balance sheets of the commercial banks.  The extraordinary increase in the money stock measures are the result of the low interest rates that people can earn on their money balances and the need of people who are economically distressed to hole transaction accounts.
The efforts of the monetary authorities are not being felt, yet, by an increase in economic activity.

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