Just how restrictive is the Federal Reserve?
According to the statistics I watch, the Federal Reserve is not restrictive at all.
If one looks at the growth of the money stock, in this case the broader M2 measure of the money stock, we see that year over year for the four weeks ending March 26, 2019, was 4.2 percent.
In terms of the historical data, this does not represent a banking system that is restricted at all.
And, the December 2017 to December 2018 growth rate of the M2 measure was 4.5 percent, which was down slightly from the 4.9 percent rate of growth from December 2016 to 2017.
There is no indication that the banking system is feeling any kind of restraint from monetary policy.
Looking at another measure of commercial bank liquidity, the Reserve Balances with Federal Reserve Banks, a proxy of “excess reserves” in the banking system, we see that commercial banks have over $1.6 trillion in excess reserves.
This figure is down from $2.2 trillion on September 27, 2017, just before the Fed began to shrink its securities portfolio, but above the $0.007 trillion held by the commercial banking system just before the beginning of the Great Recession in September 2007.
The commercial banking system kept “excess reserves” of less that $10.0 billion… yes, billion… for most of the 2000s.
Another indication of the lack of pressure on commercial bank reserves is that fact that the Federal Funds rate, the target rate of current monetary policy, hardly changes at all.
For example, since the change in the Fed’s target range for the Federal Funds rate to 2.25 percent to 2.50 percent, which was last adjusted on December 21, 2018, the daily effective Federal Funds rate has been 1.40 percent to 1.41 percent. Really, showing no variation at all.
Before that, when the range was 2.00 percent to 2.25 percent, the daily effective Federal Funds rate was either 2.19 percent or 2.20 percent.
There is seemingly no market pressure at all on the Federal Funds. To me, this is a sign that there are no pressures at all on the liquidity positions of commercial banks. In fact, I would argue that there are little or no pressures at all on the commercial banking system at this time and commercial bank executives at “playing by the Fed’s rules” when it comes to current banking activities.
As I have written about this situation many times in recent years, there are two things dominating the commercial banking system right now. First, the Federal Reserve continues to conduct monetary policy in a way where they err on the side of too much monetary ease. The Fed doesn’t want to “make a mistake”!
Second, the commercial banking system is behaving very conservatively. They do not want to upset the cart by “ticking off” the regulators, or by being too aggressive on the lending side. The moderate growth in the monetary stock cited above is a result of this latter behavior.
One sees, I believe, the consequences of these efforts on the Fed’s balance sheet.
The Federal Reserve has been shrinking its portfolio of securities since September 27, 2017. Between that date and the end of the most recent banking week, the securities portfolio, including the premiums and discounts recorded on the Fed’s balance sheet, has declined by $518 billion.
This is a little less than the Fed originally scheduled, but close enough to fulfill their promise.
Reserve Balances with Federal Reserve Banks, the proxy for commercial bank “excess reserves”, declined by a little more than this, approximately $550 billion.
The $550 billion drop represents a 25 percent decline in commercial bank excess reserves as shown on the Fed’s balance sheet. Not bad.
And, the Fed has done this with little, if any, market disruptions or bank disruptions.
A good job as far as I can see.
The question is, where to go in the future?
Fed officials have seemingly backed off from any further increases in its policy rate of interest. Any change here will be “data driven.”
As far as continuing to reduce the size of its balance sheet, the Fed will continue for a while longer and then will consider stopping this effort. Again, this, I believe, will be data driven.
From where I sit, I don’t think much else should be done at this particular time.
The US economy continues to expand at a modest but steady pace. The problems seem to be coming from offshore, from slow economic growth in Germany and the eurozone, from China, from the Brexit situation and from political uncertainty coming from… about everywhere.
Furthermore, the performance of the US economy, as I have written about regularly, seems to be dominated by supple-side factors, things that monetary policy has little or no direct influence over. The employment numbers released on Friday seem to confirm the continued strength in the economy.
I’m not sure that lowering short-term interest rates would do any good at this time. It seems as if pressure is coming on the Fed from the White House because of the currently inverted yield curve.
As I have written recently, I am not that concerned with the current situation. Generally, yield curves invert in the later stages of a business cycle because the Federal Reserve is attempting to tighten up monetary policy and is overtly attempting to raise short-term interest rates above longer-term interest rates in an effort to slow down the economy.
We have gotten into our current position because of the drop in longer-term yields as lower growth expectations have become built into the longer-term nominal rates. There has been no overt effort on the part of the Fed to produce an inverted yield curve, as is usually the case.
Finally, with so much liquidity already in the banking system, an effort to “flood the system” with more reserves would do little or nothing to the supply-side of the economy unless a major change took place in business attitudes.
My feeling is that the Federal Reserve needs to keep on, keeping on.
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