Bloomberg reported yesterday that the Federal Reserve is encouraging more hoarding of excess reserves by banks shoring up its efforts to "sterilize" its injections of liquidity to the banking system:
Great question from "confused." Here are my thoughts on this matter.Nov. 5 (Bloomberg) -- The Federal Reserve boosted the interest rate it pays banks for the excess cash they keep on deposit, aiming to prevent its record injection of funds into the financial system from affecting its monetary policy.The WSJ's RTE blog also noted this development and reported the Federal Reserve believes this move "would help foster trading in the funds market at rates closer to the FOMC’s target federal funds rate." In response, a perplexed reader named "confused" left the following comment at the RTE blog:
``The rate on excess balances will be set equal to the lowest Federal Open Market Committee target rate in effect during the reserve maintenance period,'' the Fed said in a statement. The federal funds target stands at 1 percent.
Why? The entire point to flooding the market with liquidity was to get inter-bank and bank-corporation lending started again. If that leads to a traded fed-fund rate less than the target rate, that just means the excess liquidity still needs time to work. This move seems to completely negate the prior efforts. I ask again: why???
Update: A reader in the comments section directs us to FT.com/Alphaville where Sam Jones provides further insight on this development. He argues we are in a liquidity trap, the Fed now recognizes it , and as a result it may cut back on sterilizing its liquidity injections. I hope Sam is correct. What do you think?
