Abstract
What problem the Fed and other central banks are solving by printing money and letting interest rates fall to zero is the focus of this paper. This activity does not appear to affect nominal GDP or inflation prior to COVID, and yet central bank liabilities have continued to rise. This suggests the presence of rising cash demand that has prevented excess cash and inflation pressures from emerging. While there was some hope that quantitative easing would be a new instrument in addition to interest rates as far as monetary policy goals were concerned, this has not proved to be the case. Instead, banking system demand for central bank liabilities keeps rising as an endogenous response to the changed business models of banks forced on them by post-crisis re-regulation and extremely low interest rates. These ideas were tested with cointegration and error correction econometric techniques. Examples of the growing risk of leverage and counterparty risks in this disequilibrium process are provided.
Highlights
This paper argues, that there is a demand for central bank reserves which has prevented this from happening
This paper has sought to show that since 2008 the regulatory and monetary policies adopted have accelerated a shift in bank business models that has created a demand for central bank money
Part of this demand has been mandated by the Liquidity Coverage Ratio (LCR), requiring banks to hold more liquid assets depending on size and complexity
Summary
Almost two decades ago, Goodfriend (2002) pointed out that were the Fed to pay interest on bank reserves, it would set a floor for the Fed Funds rate. The approach to policy appears to be unstable by both promoting and accommodating this business model shift If it were not accommodated, interest rate outcomes inconsistent with (i.e., above) what the Fed was trying to achieve would emerge. The period post the global crisis and prior to COVID (2007–2019) needs to be distinguished from 2020 and 2021 This is because the latter years have both (i) the on-going structural business model change aspect that is the focus of this paper; and (ii) an additional complication of Treasury funding of the Cares Act and subsequent support for the economy (See for example Office of Management and Budget 2021). It identifies key elements, some regulatory, that have generated this very large rise in cash reserves. The final section concludes with a summary and future research possibilities
Sign-in/Register to view highlights & summary Sign-in/Register to access full text options 
Free) 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a call
