Ben Bernanke and the Federal Reserve got a lot of coverage in the press and on the web last week. The general drift of all this attention has been that Fed Chairman Bernanke started to defend his tenure at the Fed and give hope that the Federal Reserve will embark on a new round of monetary easing.
The last period of monetary easing, QE2, took place roughly from the fourth quarter of 2010 into the second quarter of 2011. Since then things have been relatively quiet on the Federal Reserve front…for over a year now!
If we look at the year-over-year numbers, the monetary base is down by slightly more than 1.0 percent, total reserves in the banking system are down by more than 3.0 percent, and excess reserves in the banking system are down by more than $100.0 billion.
Looks like the Federal Reserve has been anything but aggressive, with respect to monetary policy, over the past year.
In terms of money stock growth, the most recent M1 measure of the money stock has risen, year-over-year, by close to 16.0 percent. Money continues to run out of short-term assets that are paying almost no interest and this includes bank time and savings accounts at financial institutions and money market funds. Retail money market funds lost over $35 billion in assets from August 2011, to August 2012.
As a consequence, the non-M1 portion of the M2 money stock measure has only risen by a little less than 6.0 percent, leaving the M2 money stock measure to grow at only about 8.0 percent.
Funds continue to move from interest-bearing assets to transaction assets (demand deposits) and currency. As I have mentioned many times before this tends to be a sign, not only of low interest rates on short-term assets, but also the weak state of the economy, unemployment, and the problems in the housing area.
The year-over-year rate of growth of currency outstanding has been near historical highs, more than 8.0 percent and has been at this level for three years or so. People go into currency because they need the "ready" spending money because many are living on next-to-nothing.
Over this past year, the Federal Reserve has done very little on its balance sheet.
This loss of excess reserves, the $100 billion mentioned above, has, seemingly, not put pressure on the banking system, however. The Federal Funds rate, a barometer of the pressures that exist in the money market, has remained well within the target range set by the Federal Reserve and has not required any overt action on the part of the Fed to keep it within this range.
The effective Federal Funds rate, in the latter part of 2011, was in the range of 6 basis points to 10 basis points. This rate began to rise in February 2012, rising to a high of 18 basis points in late spring and early summer. However, it is now averaging around 13 basis points
Thus, for the last year, the effective Federal Funds rate stayed well within the Fed's target range. And, this occurred during a time when the excess reserves in the banking system were declining. The only conclusion that one can draw from this is that there were little or no "demand pressures" on the money markets during the past year and even during the last eight months or so when the effective Federal Funds rate was rising.
To reinforce this conclusion, one only need look at the Fed's portfolio of securities. Year-over-year, the Fed's holdings of securities decline by almost $77 billion. In the last tree months the decline was more than $31 billion, and over the last four weeks the decline was almost $24 billion.
The Federal Reserve was not conducting open market operations during the past year to keep the Federal Funds rate within the Federal Reserve's target range!
Contributing to the decline in reserves within the banking system was an $86 billion flow of currency from the Federal Reserve into circulation. The Federal Reserve supplies currency to the economy "on demand." Thus, when the demand for currency is high, as it has been recently, as more and more people demand money from the banking system, the Fed lets it flow out to meet the demand. This is consistent with what we saw in the money stock statistics mentioned above.
Looking specifically at the last four-week and 13-week period, we see roughly the same behavior as is captured over the past 52-week period.
As mentioned above, the Federal Reserve saw its securities portfolio decline by $24 billion over the past four weeks and by $31 billion over the past 13 weeks. Thus, factors causing bank reserves to decline amounted to roughly $38 billion over the past four weeks and $30 billion over the past 13 weeks.
On the other side of the balance sheet currency flowed out of the commercial banking system into general circulation…$9 billion in the last four weeks and $13 billion over the past 13 weeks. These flows were offset by government deposits leaving Federal Reserve banks, the government returning the deposits to the commercial banking system. Roughly $40 billion in deposits left the Fed over the last 13-week period, almost all of the funds leaving in the past four-week period.
Thus, the banking system was supplied reserves from the liability-side of the Fed's balance sheet through this flow of deposits into the banking system that more than offset the flow of currency into circulation.
Summary: over the past year…and over the past month and past quarter…the Federal Reserve has actually allowed its holdings of securities to decline! The Fed also supported substantial increases in currency that flowed into private hands. Both of these factors were more than offset by declining government deposits at the Federal Reserve that flowed into the banking system.
Overall, reserve balances at the Federal Reserve and excess reserves in the banking system declined by relatively substantial amounts. The Fed also allowed total bank reserves and the monetary base to decline during this time period.
However, this reduction in total reserves and excess reserves did not result in the banking system experiencing any form of "tightening" effect. The Federal Funds rate stayed within the Fed's target range and this occurred during the period that total reserves and excess reserves in the banking system actually declined.
Conclusion: loan demand remains extremely weak and there is very little pressure on short-term interest rates to rise at this time. And, the commercial banking system continues to be flush with funds.
What can the Federal Reserve do in a situation like this to stimulate the banking system and the economy? This is the dilemma that Mr. Bernanke and the Fed face. The economy is not increasing at a very rapid pace. Unemployment remains too high. And, many recent statistical releases are raising concerns about additional slowing. What can the Fed do?