I’ve run into quite a bit of confusion in conversations discussing bank reserves, and found occasion to get precise on the usage in recent comments. I thought I’d share it with others. This has been vetted by several who are more worthy than I, so I feel quite confident in offering it up.
1. “Reserve balances.” These are banks’ deposits at the Fed. Similar to your credit balance in your checking account (except in “bank money”). They’re liabilities of the Fed, assets of the banks. They appear and are identified as such on banks’ (and the Fed’s) balance sheets.
2. “Required reserves.” A regulatory amount (percentage of deposits) that banks are required to hold in specified “safe” assets — significant examples being treasuries, vault cash, gold (in their vaults or the Fed’s), and…reserve balances. The term “required reserves” does not appear on banks’ balance sheets.
3. “Excess reserve( balance)s.” I add “balances” because this explicitly refers to that particular type of holdings — deposits at the Fed. A bank could (in theory) have sufficient required reserves held in treasuries and vault cash, so all of its reserve balances could be “excess reserves.” (Depending on which of the bank’s assets you might want to point to and arbitrarily call its “required reserves.” That thing is a regulatory (pro)portion, not a specific set of financial assets, or a balance-sheet entry.)
What’s funny here: Excess Reserves are explicitly not reserves in the sense of “funds that are required to be ring-fenced under law so depositors can withdraw their money or transactions can clear.” By definition, they’re the banks’ deposits at the Fed that are not ring-fenced.
So excess reserves are not actually “reserves.” No wonder people get confused.
Required reserves aren’t necessarily held in the form of reserve balances.
Reserve balances are not necessarily required reserves.
(Which is why I would prefer a better term than “reserve balances.” Fed deposits?)
Cross-posted at Asymptosis.
Just to make things a little more precise, vault cash, which essentially is the difference between currency held by the public and currency in circulation, is not always used to satisfy reserve requirements. On average only about 73% of vault cash has been used that way since November 1959. And prior to that, vault cash was not permitted to be used to satisfy reserve requirements.
Those who don’t follow legal reserves aren’t aware that the Fed overlays their data revisions. Any given a shortfall in RRs will be masked by the Fed’s attempts to rebalance the system. The flash crash of May 6th 2010 was the direct result of the Board’s mismanagement of the money stock. The 8% drop in RRs prior to the crash was later erased to reflect an increase in RRs. Anyone trying to run a time series will be fooled. I.e., the banks respond immediately to an injection of liquidity.
One shouldn’t confuse liquidity reserves with legal reserves. The only type of bank asset the Fed’s in a position to constantly monitor & absolutely control are interbank demand deposits owned by the member banks’ & held at their District Reserve Bank, or pre-1959 requirements pertaining to assets (like the ECB). This was the original definition for legal reserves.
Allowing the member banks to use liquidity (prudential) reserves to satisfy their legal reserve requirements makes the FRB-NY’s “trading desks” job of legal reserve management (monetarism) harder.
Note also that “applied” vault cash (that quantity used to meet reserve requirements) & “surplus” vault cash have both been excluded in the tabulations of the money stock.
“Applied” vault cash is included in the total & required reserve figures. Whereas “surplus” vault cash is omitted from required reserve figures. There are actually 2 different calculations for required reserves, the FRB-STL’s & the BOG’s. Note one major difference is that the BOG adds “surplus” reserves to its total & excess reserve figures.
Cross post: I’ve watched reserves since 1973 (after Pritchard, Ph.D., economics, Chicago 1933 explained their significance).
But (1) e-mail 11/16/06: “Spencer, this is an interesting idea. Since no one in the Fed tracks reserves…” senior V.P. Fed’s technical staff (Big Brother is watching). And (2) “Donald Kohn “I know of no model that shows a transmission from bank reserves to inflation”
So you see the problem? Yes, I maintain a time series (for trading purposes), & it has to be periodically reconstructed (e.g., Reserve Simplification 7/11/13). I.e., it’s R^2 is affected as the weighted arithmetic average of reserve ratios & reserveable liabilities remains constant.
Manmohan Singh, Peter Stella tried to make some kind of point: “that from 1981 to 2006 total credit market assets increase by 744%”. But Inter-bank demand deposits owned by the member banks held at the District Reserve banks fell by $6.5 billion?
There are two different reserve figures. The BOG’s reserve figure fell by 61% from 1/1/1994-1/1/2001. The FRB-STL’s figure (based on its RAM calculations), remained unchanged during the same period. And the CBs ceased to be reserve “e-bound” c. 1995 (roc’s still work regardless).
S&S neglect to point out that increasing levels of vault cash (ATM networks) & retail & commercial sweeps programs, etc., contributed to the decline.
Cross Post from MoneyIllusion: Contrary to the conventional wisdom, reserves are binding (be they prudential or otherwise). Every major downdraft in the economy, & every major downdraft in the financial markets, was the direct result of decelerating or negative rates-of-change (roc’s) in required reserves (RRs). The CBs are legally required to hold reserves contingent upon the level of transaction based accounts 30 days prior.
“The close relationship between the growth rates of required reserves and total checkable deposits reflects the fact that reserves requirements apply only to checkable deposits” – Daniel Thornton
And 93%-96% of all demand drafts clear thru transaction based accounts (not thru M2). Further, roc’s in RRs mirror roc’s in nominal-gDp (though its R^2 is lower than bank debits). Manmohan Singh’s & Peter Stella’s papers on this are disingenuous.
I.e., for the last 100 years, the lag effects for money flows have been mathematical constants. The 10 month roc in RRs equals the proxy for real-output & the 24 month roc in RRs equals the proxy for inflation. This is inviolate & sacrosanct. Bankrupt you Bernanke caused the Great-Recession by himself (regulatory malfeasance notwithstanding).
The BEA’s latest estimate for the decline in real-gDp for the 4th qtr of 2008 was a decrease of 8.9%. I posted this in Dec 07 as the Commerce Department was saying retail sales in Oct 2007 increased by 1.2% over Oct 2006, & up a huge 6.3% from Nov 2006:
POSTED: Dec 13 2007 06:55 PM |
10/1/2007,,,,,,,-0.47,,,,,,, -0.22 * temporary bottom
11/1/2007,,,,,,, 0.14,,,,,,, -0.18
1/1/2008,,,,,,, 0.59,,,,,,, 0.06
2/1/2008,,,,,,, 0.45,,,,,,, 0.10
3/1/2008,,,,,,, 0.06,,,,,,, 0.04
4/1/2008,,,,,,, 0.04,,,,,,, 0.02
5/1/2008,,,,,,, 0.09,,,,,,, 0.04
6/1/2008,,,,,,, 0.20,,,,,,, 0.05
7/1/2008,,,,,,, 0.32,,,,,,, 0.10
8/1/2008,,,,,,, 0.15,,,,,,, 0.05
9/1/2008,,,,,,, 0.00,,,,,,, 0.13
10/1/2008,,,,,,, -0.20,,,,,,, 0.10 * possible recession
11/1/2008,,,,,,, -0.10,,,,,,, 0.00 * possible recession
12/1/2008,,,,,,, 0.10,,,,,,, -0.06 * possible recession
Trajectory as predicted: