This Bloomberg article by former New York Fed President Bill Dudley caught my eye:

In the fall of 2008, the Fed needed to supply large amounts of liquidity to support the ailing economy and unfreeze gridlocked financial markets. These liquidity provisions blew up the Fed’s balance sheet and the amount of reserves in the financial system. Fortunately, because the legislation for the Troubled Asset Relief Program gave the Fed the immediate authority to pay interest on reserves, the Fed could maintain control of short-term interest rates even with a lot of excess reserves and an enormous balance sheet.

Yes, and “fortunately” Congress gave President Bush the authority to invade Iraq if he felt it were in the national interest.  And “fortunately” Congress gave President Trump the authority to set tariff rates.  And “fortunately” Congress gave President Nixon the authority to set nationwide wage and price controls.  And “fortunately” Congress gave President Johnson the authority to send 500,000 troops to Vietnam.

HT:  David Beckworth



33 Responses to “Fortunately?”

  1. Gravatar of Ralph Musgrave Ralph Musgrave
    8. January 2020 at 03:49

    Interest on reserves is a way of rewarding the rich for hoarding cash. I trust I don’t need to explain why the rich think interest on reserves is a great idea…:-)

  2. Gravatar of rayward rayward
    8. January 2020 at 05:20

    Dudley may believe that paying interest on reserves provided an incentive for banks to increase their reserves, which added confidence both in the banks and in the (perception of the) Fed’s determination to avoid inflation. I think Dudley was referring to 2010 and the additional round of QE, to which the inflation hawks were sounding the alarm and the Fed was getting resistance from some vocal members of the Fed’s leaders.

  3. Gravatar of Todd Ramsey Todd Ramsey
    8. January 2020 at 06:37

    Do you think purpose of IOR was to provide political cover for the Fed to recapitalize banks?

  4. Gravatar of Matthias Görgens Matthias Görgens
    8. January 2020 at 08:15

    George Selgin has a whole book and lots of blog posts on interest on excess reserves.

    And, No, it’s not a (direct) subsidy for rich people.

  5. Gravatar of SG SG
    8. January 2020 at 08:28

    It’s all right there in the public record. Even today the SF Fed website includes this helpful description of the logic behind IOR:

    “[Implementation of IOR] was important for monetary policy because the Federal Reserve’s various liquidity facilities initiated during the financial crisis caused upward pressure on excess reserves and placed downward pressure on the Federal funds rate. To counteract these pressures, on October 6, 2008, the Federal Reserve Board announced that it would begin paying interest on depository institutions’ reserve balances.”

    In other words, the Fed decided that it was important for short term interest rates to remain HIGH, at the level of 2%, which was what the target fed funds rate was on Oct 6. Note that at that time, the fed hadn’t cut interest rates at all since April 30.

    The more I read, the more I think that Scott has been EXACTLY right that the contractionary policy of IOR was a critical mistake by the Fed. It was implemented at exactly the wrong time – after the fed had insanely decided to keep rates unchanged in the aftermath of the Lehman Brothers’ bankruptcy.

    Go read a news report about October 6 – equity markets plunged 3.5%-4% on that day, but I haven’t found a single one that identified the new IOR policy as a factor.

    Unfortunately the Fed is full of people like Dudley who, bizarrely, still don’t get it.

    Fortunately, the media is now more attuned to Fed policy so I don’t think the Fed would get the same pass this time around.

  6. Gravatar of Ralph Musgrave Ralph Musgrave
    8. January 2020 at 09:21

    I agree with Matthias Görgens that IOR is not a DIRECT subsidy of the rich. However IOR improves banks’ profits, which in turn will sooner or later boost interest paid to depositors. And the people with the biggest deposits are . . . . the rich!

  7. Gravatar of milljas milljas
    8. January 2020 at 10:30

    I thought I was in bizarro-world after reading Cochrane’s take on this and how he likes the big balance sheet and IOR. Did Krugman hack his blog? I guess Canada doesn’t exist nor does the historical US where it got by with tiny amounts of reserves and things went smoothly, monetary policy wise anyway.

    I see that George put something across on his blog and at Grumpy.

  8. Gravatar of Benjamin Cole Benjamin Cole
    8. January 2020 at 10:47

    Well, interest on excess reserves strikes me as the sort of policy that one could expect from a captured regulatory agency, such as the Federal Reserve.

  9. Gravatar of Michael Rulle Michael Rulle
    8. January 2020 at 13:44

    I am not sure what Scott is mocking—he likes mystery theater!. I think its that the Fed already had the power to pay interest on reserves so “fortunately” was a dumb comment. Since he also uses examples of Presidents using power they already had, (to create bad policy), I also assume—as he has said many times before—that he did not like IOR—so a double “fortunately”. I am also not sure when he thinks Bernanke began to realize he was tightening and what he actions he took to reverse it—but IOR was certainly not one of them.

    At the time, i.e., 2008—all I could think of was we were—-as Scott has also said before—-trading bonds for “T_bill” equivalents with IOR. I know I did not get what we were trying to accomplish at the time or now.

    I also thought TARP was absurd—-when it was passed—they didn’t even know why they passed it—as later actions demonstrated. It reminds me now of having “to pass ObamaCare to find out what it is”–even though, of course, that came later when Obama was President.

  10. Gravatar of Thaomas Thaomas
    8. January 2020 at 14:10

    Dudley might say anything. What could have been the reasoning of sensible people like Bernake or Yellin to prevent the fall of ST interest rates? On the other hand, if they had been willing to be aggressive (whatever it takes) with QE, did the payment IOR do serious damage?

  11. Gravatar of Brian Brian
    8. January 2020 at 16:42

    Well there was a report at the time that a small positive rate of interest on reserves would maintain confidence in money market funds. Prevent a run. Consider that if the market rate for very short term Treasury bills is negative 5 bp and it rises to positive 5 bp. It’s noise but the most risk averse money market fund will experience a capital loss. I do not recall if our blog host commented on the logic of this if in fact it was the Federal Reserve’s motivation.

  12. Gravatar of Brian Brian
    8. January 2020 at 16:49

    To clarify, in the very short term the interest earned or interest paid is negligible so the capital gain and capital loss are the dominant effects.

  13. Gravatar of msgkings msgkings
    9. January 2020 at 08:51

    @Michael Rulle: things were happening fast in September 2008, and no one had ever dealt with what was going on. Some of the decisions in hindsight could have been better, but overall they did a pretty good job. The firemen put out the fire and prevented a Great Recession from becoming a Great Depression II Electric Boogaloo.

    One thing often overlooked is the change in mark-to-market rules that Barney Frank pushed. From 1937 to 2007, the MTM rule was based on cash flows and long term outlook. In 2007 they changed it to the actual market price, so in the crash perfectly good performing loans were marked way too low since there were no buyers, and this wreaked havoc on banks. It was changed on March 9, 2009, the exact bottom of the stock market.

    No one here would have done much better, including Professor Sumner.

  14. Gravatar of Carl Carl
    9. January 2020 at 10:31

    Regarding your comment “No one here would have done much better, including Professor Sumner.” I hope you’re wrong. The raison d’etre for this blog is that the Fed wouldn’t have made the mistakes it made if it had been monitoring the correct metrics.

  15. Gravatar of msgkings msgkings
    9. January 2020 at 11:26


    Fair enough, I just wanted to push back on all the 20/20 hindsight and Monday morning quarterbacking everyone has done since.

    They did a decent job in crazy, fast-moving, unique times. No one is perfect.

  16. Gravatar of Carl Carl
    9. January 2020 at 12:04


  17. Gravatar of ssumner ssumner
    9. January 2020 at 12:46

    Todd, No, I think the intent was to reduce aggregate demand.

  18. Gravatar of tom s tom s
    9. January 2020 at 23:28

    The effect is contractionary. What was the Fed thinking?

  19. Gravatar of Benjamin Cole Benjamin Cole
    10. January 2020 at 03:06

    msgkings and Carl:

    To be sure, hindsight is 20/20.

    But let us also review the monetary weapons the Fed had in 2008/9:

    1. They could lower short-term rates, but rates would likely hit the floor anyway. Zero-bound etc. And would lower rates really much boost bank-lending? Long-term rates tend to be set by global markets.

    2. The Fed could buy US Treasuries, which are very liquid and very fungible, in globalized capital markets. So, they could try to inflate global bond values, and thus asset values, though bond purchases. Sisyphus come to mind?

    3. US banks did have larger reserves as a result of the Fed’ QE program…but again, banks only lend when they think lending is a good idea. And a primary lending market for US commercial banks is property lending…but who lends on property when property values are going down?


    So, did the Fed have monetary weapons or mere pop-guns in 2008/9—especially when it comes to stimulating the economy of defined geographic region, such as that of the Unite States?

    I think Scott Sumner is correct in that the Fed was scared that large commercial bank reserves would lead to a too-large boom in domestic lending, and so they invented IOR. Which is a bit like the circus Fat Lady worrying her sugar-free cokes will make her emaciated. But, it was a nice bit of grifting for commercial banks too.

    There are some caveats: Michael Woodford posits that QE in combo with fiscal deficits is a US-centric helicopter drop. So that would be stimulative inside US borders, to some degree.

    And (put on your tin-foil hats, this is even more theoretical) let us imagine money is fungible, and what happens on the margin between bond markets, and consumption, is the key.

    So, there are people who sold bonds 2009-2014 and then consumed the proceeds. They bought goods and services after selling bonds.

    We can posit that when the Fed bought bonds, it in effect was buying bonds from people who exited asset markets to engage in consumption. Suppose we have a $200 trillion global bond market, and the Fed buys $4 trillion in Treasuries, and concurrent to the Fed purchases, we see some bond-sellers exit the asset market and spend $4 trillion. Well?

    The interesting thing about when the Fed buys a bond from a bond-seller is this: the seller to the Fed can engage in immediate consumption, but no one in the private sector has to give up immediate consumption. In other words, normally when I sell a $100 Treasury bond to finance my consumption, I sell the bond to another private party who then must hold $100 of consumption in abeyance as long as they own the bond. I transfer delayed gratification.

    But when I sell to the Fed, I can spend the loot, and no one else has to give up the right spend the loot.

    AFAIK, central bankers do not ponder QE in this way.

    Today, central bankers nearly in unison are calling for larger budget deficits.

    In the end, I quote my late, great Uncle Jerry: “If you are not confused….then you probably do not understand the situation.”

  20. Gravatar of Christian List Christian List
    10. January 2020 at 09:11

    things were happening fast in September 2008, and no one had ever dealt with what was going on.

    They did a decent job in crazy, fast-moving, unique times. No one is perfect.

    Maybe I got it all wrong again, but an important point of Scott’s blog seems to be that it wasn’t unique times, that the core of the problem was known before, that we knew what needed to be done, that even pretty standard monetary policy would have done the job, that the FED seems to repeat simple mistakes over and over again, and that relatively simple insights are unfortunately often forgotten.

    I doubt that the chatter about “unique times that no one has ever seen before” will get us anywhere. Don’t exaggerate the problem. The FED must recognize its simple mistakes, otherwise it will repeat them over and over again.

    There is this absurd tendency, especially in the last 20 years, that everything is supposed to be so super-complicated and complex in this modern world, and that “of course” there are no simple solutions to any problem in the world ever. Well, this attitude does not get us anywhere — not to mention that it’s just not true.

  21. Gravatar of Logan Wells Logan Wells
    10. January 2020 at 10:41

    Funny how we went from Tea Party and Gold Bugs to MMT in such a short time. Seems like academics are losing to political whims. What will happen? Probably the same thing that happened last time. Blog is spot on. Keep up the good work.

  22. Gravatar of Mike Sproul Mike Sproul
    10. January 2020 at 10:50

    What Dudley should have said:

    “Fortunately, for every dollar the Fed issued, it received a dollar’s worth of assets. Thus, every dollar issued was backed by a dollar of assets, so there was no inflation and no pressure on interest rates.”

  23. Gravatar of Jeff Jeff
    10. January 2020 at 13:55

    Way back in the seventies, when short-term rates were in double digits and reserves paid no interest, many people in and out of the Fed referred to the lack of interest on required reserves as the “reserve tax”. It was thought to be a major reason why more and more financial intermediation was taking place outside of the banks regulated by the Fed.

    Naturally, the Fed didn’t much care for this situation. Not just for bureaucratic reasons, but also because of the thoughts that (i) having lots of close substitutes for money made monetary policy less effective, and (ii) intermediation taking place outside the banking system could be very thinly capitalized, and that increases the fragility of the whole financial system, because so many of the big players in the nonbank sector are also big players in the banking sector. AIG, for example, was an insurance company, but among it’s notional liabilities were billions owed to various banks.

    So the Fed had been asking the Congress for permission to pay interest on reserves for years before the financial crisis of 2008. But notice that the “reserve tax” idea really only applies to required reserves and supplies no justification for paying interest on excess reserves. The latter is what enabled the Fed to multiply it’s balance sheet, and there was never any good reason to allow it.

  24. Gravatar of Benjamin Cole Benjamin Cole
    10. January 2020 at 17:37

    Summers calls Bernanke’s recent Ode to Monetary Policy the “Last Hurrah.”

    For those with long memories, there was a time that Bernanke visited Japan and advised helicopter drops…

    The nice thing about macroeconomic debates is that no one is ever wrong.

  25. Gravatar of ssumner ssumner
    11. January 2020 at 00:51

    Jeff, Good comment.

  26. Gravatar of Michael Rulle Michael Rulle
    11. January 2020 at 07:57

    @Christian List,@msgkings

    Agree that Scott’s hypothesis is this was not “new”. And he is so confident about this it is very difficult to disagree with him. But, at the time, MM was not yet fully thought through —-let alone believed——. In the end, 2008 did not result in disaster——in fact, the market low was 6 month’s later. Thinking out loud, 2008 was the end of the crisis—-although it did not feel that way. We can only hypothesize alternative histories. But Scott’s view of the world is seductive—-and I hope true——because if true—-as he forecasts—-there will be very few recessions——assuming of course that central banks believe it too.

  27. Gravatar of Thaomas Thaomas
    12. January 2020 at 04:05


    No body is perfect but it was perfectly clear in 2008-present that the price level was no on a 2% p.a. track and until recently unemployment was greater than what had been considered “full.” Therefore the Fed was not providing enough monetary stimulus. Why is one of the great political mysteries of our time.

  28. Gravatar of msgkings msgkings
    13. January 2020 at 08:38


    I agree with that, my comment is more about the Fed and Treasury and how they handled 2008. I think under the circumstances they did a pretty good job, and yet there’s plenty of people bashing them with perfect hindsight, as if the critics would have done better. Probably not.

    Afterwards yes they were too tight. Decent reasons why include the fact that they had just done so much that it was hard to get the political backing to do a lot more, and that they were stuck in old paradigms. They deserve criticism for that.

  29. Gravatar of Michael Rulle Michael Rulle
    15. January 2020 at 12:15

    Scott—story in WSJ 1/15—headline

    “The Era of Fed Power Is Over—Prepare for a More Perilous Road Ahead”

    Just as you and others have begun to make real headway—we get this story—I choose to view it as similar to all those forecasts about peak oil going to 200—when it was 100—and before it went to 40.

  30. Gravatar of Benjamin Cole Benjamin Cole
    15. January 2020 at 16:32

    “As far as the burden of Japan’s debt, interest payments on Japan’s debt will amount to 0.005 percent of GDP this year, according to the I.M.F. That would be equivalent to interest payments of roughly $1.2 billion in the U.S. economy. (Our interest payments will be a bit over $200 billion this year, after netting out money rebated by the Federal Reserve Board.) The I.M.F. projects that Japan’s interest burden will turn negative next year, as investors are paying the country money to hold its debt.”—Dean Baker

    This is a fascinating result. The taxpayers of Japan will actually be collecting interest on the national debt.

    Japan is not the United States, and I suspect we have a weak understanding about how demographics and housing costs affect inflation.

    But if the United States could figure out how to reduce population and reduce housing costs, US taxpayers might also find themselves collecting interest on the national debt.

  31. Gravatar of Thaomas Thaomas
    16. January 2020 at 03:10

    @ nsgkingd


    I agree with that, my comment is more about the Fed and Treasury and how they handled 2008.”

    OK, but my comment was a) why someone like Bernanke would have wished to prevent a QE from resulting in a fall in ST interest rates and b) if IOR would have done much damage if the Fed had been targeting the PL trend and employment with “as much as it takes” of QE to achieve these targets.

  32. Gravatar of Carl Carl
    16. January 2020 at 10:26

    Here’s Bernanke in his own words explaining why he did what he did during the crisis:

    To me it backs up msgkings point that he did pretty well in a tough spot. Now lets look at improving the models.

    Regarding IOR, here’s his take on the effect of IOR on bank lending(

    “Before December, the Fed paid banks one-quarter of one percent on their reserves. If the Fed had not paid interest, the return to reserves would have been zero. Accordingly, the only potential loans that would have been affected by the Fed’s payment of interest are those with risk-adjusted short-term returns between precisely zero and one-quarter percent—surely a tiny fraction of the total. In fact, over the last four years bank lending has increased at about a 5 percent annual pace (including around a 7 percent annual rate the past two years), with only residential mortgage lending lagging in the aftermath of the housing bust.”

  33. Gravatar of ssumner ssumner
    17. January 2020 at 17:41

    Carl, Bernanke did what he could under difficult circumstances, as much of the FOMC was opposed to more stimulus. At the same time, Bernanke himself admits (in his memoir) that the Fed was too tight in late 2008.

    And IOR was more than a quarter point in late 2008. In any case, interest rates have no bearing on how contractionary the stance of monetary policy is. Even a 1/4% rate can be HIGHLY contractionary if the natural rate is even lower.

Leave a Reply