Excess Reserves Declining

Keep this one on your radar.   Excess reserves of depository institutions are beginning to decline,  down $183 billion, or 11.3 percent,  from their peak in November 2011

This is where much of the Fed’s money printing or balance sheet expansion has gone since the beginning of the financial crisis.   The Fed injects liquidity through its asset purchases and the financial institutions deposit the proceeds right back at the Fed in the form of excess reserves, which now pays interest.

We believe if excess reserves are declining,  it may signal the massive liquidity created by the Fed over the past few years is starting bite and beginning to leak into the economy as credit expands.   When the economy begins to accelerate the leak could turn into a flood and that is what, we think,  some at the FOMC fear.  That is, the excess reserves turning into high powered money.

Could be wrong, but at least that’s how we see it.

Jan6_Excess Reserves(click here if chart is not observable)

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12 Responses to Excess Reserves Declining

  1. Alternatively, the reduction in excess reserves is due to banks writing down non performing loans using reserves to offset the losses to avoid showing losses on their P+L’s.

  2. william roth says:

    What do you think of the Federal Reserve’s plan for controlling these by increasing the rate paid for funds on deposit?

    • macromon says:

      That is one new tool of monetary policy. CNBC’s, Steve Leisman, says they are worried of the potential costs and losses to the Fed of those raising rates, however. Due to the sheer size.

      • william roth says:

        Since they are earning interest on the securities they purchased with QE, won’t they just use this to pay the banks and remit less money to the treasury?

  3. David King says:

    Isn’t this simply a function of the Fed previously not reinvesting coupons from maturing bonds? The total number of excess reserves has nothing to do with bank lending activity.

  4. macromon says:

    David, Don’t think though. We think its a function that financial institutions are starting to lend again, albeit, slowly. You may right, however.

  5. MG says:

    Stated purpose of QE was to raise the price of paper assets. Raising the perceived value of paper assets is better said. With that in mind, and chronic unemployment in the developed world, lack of demand, why/where would these access reserves enter the “real” economy in a trickle or a flood? The combined Bernake/Draghi Puts frown upon “real” investments into the “real” economy.

    • macromon says:

      Banks start to lend. Money supply expands. Inflation picks up. We have looked further into the data. Total reserves have declined about $44 billon y-y in Nov. Excess reserves have gone down while required reserves have gone up, signalling deposits are expanding. The healing of the financial sector looks like it may accelerate. That is why some on the FOMC are nervous.

  6. billiejones says:

    Mac,

    Can you please explain how this works? An article from “The Economist” implies that excess reserves don’t matter and that excess reserves are ONLY used for interbank lending and never result in actual lending to the public. This doesn’t make sense to me it seems that even if excess reserves were technically only used for interbank lending, at some point they would trickle to the public in the form of loans (possibly reclassified under a different name other than “excess reserves”). I would really appreciate if somebody could explain this…I’m stuck.

  7. macromon says:

    Thanks for commenting, BillieJ. Banks are required to hold a certain amount of reserves depending on the asset and loans outstanding. If they hold excess liquidity in the form excess reserves they will lend it out overnight in the Fed Funds market, which, traditionally the rate the Fed targets. If liquidity is tight, there is upward pressure on the Fed Funds rates and the Fed adds reserves to the banking system. Obviously, with the trillion plus excess reserves in the system the banks have too many reserves and could push money rates negative, which why the Fed now pays interest on excess reserves (IOER)… If banks begin to lend, they will be required hold more reserves, so even though total reserves in the financial system may remain the same, the mix will change. That is, more required reserves and less excess reserves. This is a sign credit is beginning to expand, which could be inflationary given there is so much liquidity in the system that can be multiplied into money/credit. Hope that helps.

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