For the non-cognoscenti: “IOR” is interest on reserves. Banks keep money in their accounts at the Fed. In October, 2008 the Fed started paying .25% interest on those accounts.
The Fed’s also engaged in “quantitative easing,” a.k.a. open-market purchases on steroids, creating new money and using it to buy $1.6 trillion dollars worth of bonds from banks. The money is deposited in banks’ reserve accounts.
The result: banks have $1.6 trillion dollars in excess reserves (in excess of what they’re required to hold) sitting in their accounts at the Fed.
This is the heart of the “pushing on a string” argument — giving the banks more reserves (making their holdings more “liquid”) doesn’t (necessarily) increase real-economy transaction volumes (on consumption or investment), either directly through spending by the banks or via bank loans to people and businesses who will spend it. This $1.6 trillion in new money issued by the Fed is effectively stuffed in an electronic mattress.
So I’m curious what would happen if the Fed no longer paid IOR.
I asked Scott Sumner this a while back:
if tomorrow the Fed dropped IOR to zero or even negative, what would happen to:
o Excess reserves
He gave a somewhat less than satisfactory answer:
The IOR question is a good one, and at the risk of being annoying I’m going to slightly dodge the question. I do think it would be expansionary, but it’s hard to know how much, because it’s almost inconceivable to me that it would be done by itself, without any other policy changes. It could be slightly expansionary, or if accompanied by other moves, wildly expansionary.
Less than satisfactory (for me) because he often engages in these kind of simplified thought experiments. Change Variable X, ceteris paribus: what would happen?
I’m basically asking for a free education here (hoping others would appreciate such an education as well), but I’m also hoping to spur a discussion on a tightly focused question that has not been cogently discussed, as far as I can find. (I certainly could have missed it. Pointers welcome.)
Cross-posted at Asymptosis.