Search EconLog

Best Banking: Animal Analogy Ever

PRINT EMAIL

Home
| EconLog
| Archives
| Permanent Link

Arcane banking regulations matter, but it's hard to communicate anything about them to a broader audience. Alex Tabarrok rises to the occasion with an elegant analogy:

When no interest was paid on reserves banks tried to hold as few as possible. But during the day the banks needed reserves - of which there were only $40 billion or so - to fund trillions of dollars worth of intraday payments. As a result, there was typically a daily shortage of reserves which the Fed made up for by extending hundreds of billions of dollars worth of daylight credit. Thus, in essence, the banks used to inhale credit during the day - puffing up like a bullfrog - only to exhale at night.

Alex is the only economist I know of who has highlighted the connection between the Fed's new policy of paying interest on reserves, and the apparent evidence of a liquidity trap. Yet another reason why the world should listen to him.

CATEGORIES: Monetary Policy

COMMENTS (2 to date)

Latest Comment

Jeff Hummel writes:

Bryan: I must point out that I have been warning at Liberty & Power about the payment of interest on bank reserves and its potential effects on monetary policy since the middle of October. See my posts Interest on Bank Reserves and the Recent Crisis and Recent Fed Machinations.

Posted December 1, 2008 12:30 PM

R. Pointer writes:

When I read that last night, I was shocked. These are economists running the Fed right? Is it all bull---- what they teach in Grad school about incentives? Or are the only incentives that matter the central bankers'?

Lastly, how do they unravel this? They have grabbed the lion's mane. They will never have the incentive to let go.

Posted December 1, 2008 4:34 PM

Comments for this entry have been closed

Read comments

Return to top

Blogging software: Powered by Movable Type 4.2.1.
Pictures courtesy of the authors.
All opinions expressed on EconLog reflect those of the author or individual commenters, and do not necessarily represent the views or positions of the Library of Economics and Liberty (Econlib) website or its owner, Liberty Fund, Inc.

The cuneiform inscription in the Liberty Fund logo is the earliest-known written appearance of the word "freedom" (amagi), or "liberty." It is taken from a clay document written about 2300 B.C. in the Sumerian city-state of Lagash.

Contact Site Map Privacy and Legal http://www.econlib.org