I did a couple of posts a while back asking (and concluding) what would result from the Fed ending their interest on reserves policies. (Not suggesting they do so — just wondering what the effects of that one change would be.)
I got a lot of good answers and discussion, but nobody mentioned the very interesting paper by Alex Tabarrok discussed here (emphasis mine):
…there was typically a daily shortage of reserves which the Fed made up for by extending hundreds of billions of dollars worth of daylight credit. Thus, in essence, the banks used to inhale credit during the day – puffing up like a bullfrog – only to exhale at night. (But note that our stats on the monetary base only measured the bullfrog at night.)
Today, the banks are no longer in bullfrog mode. The Fed is paying interest on reserves and they are paying at a rate which is high enough so that the banks have plenty of reserves on hand during the day and they keep those reserves at night. Thus, all that has really happened – as far as the monetary base statistic is concerned – is that we have replaced daylight credit with excess reserves held around the clock.
This explanation finds support in a post from Liberty Street Economics (NY Fed blog). The key graphic:
Cross-posted at Asymptosis.