The parabolic Fed: divorcing monetary policy from money

The Fed requires banks to hold money on reserve. 18 months ago, typical reserves at the Fed were around $7bn. Last week, bank reserves at the Fed were $592bn.

And as we’ve noted before, the Fed is actively trying to increase this number. It has increased the interest payable on those reserves (or rather, decreased the penalty to the Fed funds target), to encourage more deposits.

This policy is remarkably similar to one instituted by the Bank of Japan. A ZIRP (snap!) was supplemented by a policy of encourage huge bank reserve growth at the BoJ. The policy was supposed to do two things: keep the ZIRP realistic and effectively transmit its effects, and encourage banks to lend normally because of the surety of their huge reserves.