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Is the Fed running out of policy tools?

A worthwhile read is an article titled “Interest on Excess Reserves and Cash 'Parked' at the Fed,” which was posted on the FRBNY's blog on Monday. It explains that all that cash that banks have does not in any way reflect their unwillingness to lend: “In the aggregate, therefore, these balances do not represent 'idle' funds that the banking system is unwilling to lend. In fact, the total quantity of reserve balances held by banks conveys no information about their lending activities - it simply reflects the Federal Reserve's decisions on how many assets to acquire.”

During the week of Aug. 22, deposits at the Fed held by depository institutions totaled $1.51 trillion, near the record high of $1.68 trillion during the week of July 13, 2011. Yet commercial and industrial loans have increased by $268.1 billion since late 2010.

The real zinger in the article is that cutting the interest rate the Fed pays on those deposits to zero from 0.25% is a bad idea: “Lowering this rate may also lead to disruptions in markets that weren't designed to operate at very low interest rates.” Paying a negative interest rate would be a really bad idea since “banks may choose to store currency rather than hold deposits at the Fed, and households may prefer holding cash if banks impose significant fees on deposits.” In other words, the Fed really is running out of policy tools, though there still is open-end QE3.

Source: Ed Yardeni — Ed Yardeni is the president and chief investment strategist of Yardeni Research Inc., a provider of independent investment strategy and economics research for institutional investors.