... in the last three weeks, something very significant has happened. The non-bank part of the Fed’s liabilities has stopped expanding: combined Treasury deposits with the Fed plus cash in circulation has actually fallen from $1.517 trillion in the week ending Oct 29 to $1.467 trillion in the week ending Nov 12.

Instead, the Fed’s increased lending to the financial system over the last two weeks (+$325 billion) has been matched by an increase in the volume of deposits the commercial banks are hold with the Fed (+$331 billion).

In other words, the Fed is now lending to the banks, which are now lending the funds back to the central bank. The Fed is no longer supplying just narrow liquidity needed to enable the market to function. It is now supplying excess funds (more than the banks need) which are being recycled back into the central bank.


The central bank has successfully driven a wedge between interest rate policy (the target fed funds rate) and the quantity of money created (cash plus reserve balances). This was the explicit aim, foreshadowed a recent paper by the Federal Reserve Bank of New York. The Fed is now free to expand bank reserves almost without limit while maintaining the fed funds target (at least very loosely).

And if we're all lucky, this will not work as splendidly as it has in Japan!

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