Noah Smith has a far better critique of Feldstein's attempt to link excess reserves with the inflationary dog that didn't bark. It's a bit late in the day and believe me, it's not an admission of guilt. Rather, you could view it as a sort of I-know-why-this-hasn't-happened-somebody-gamed-the-system sort of article.
But Smith's approach is simple. Treat the IOER (Interest on Excess Reserves) as the 'safe asset'. If it's less than the T-bill rate then the latter is the safe asset. Thus,
"The IROR is 0.25%. The T-bill rate is just over 0%. This means that the difference in the expected real rate of return between a world with an IROR and a world without an IROR is about 0.25%. In a world without an IROR, banks lend to any risky project with an expected real rate of return of S. In a world with an IROR, banks lend to any risky project with an expected real rate of return of S + 0.25%"
What he means in terms of Feldstein's claim, is that the band between a project's real rate of return and the +0.25% IOER has a lot of activity (projects to lend for) - R<project<R+0.25%
Basically it is, as Feldstein tries to assert, this that is holding back the excess reserves. If that spread disappeared and the 'safe asset rate' decreased by 0.25% (IOER), the reserves would flood the economy like chimera and inflation would finally bite, forget bark.
So where does the answer lie?
"The answer must lie elsewhere; it must be the case that either S is very high, or there are very few projects with decent expected rates of return, or maybe some sort of institutional constraint on the speed with which banks can ramp up lending. But that little 0.25% IROR can't be what's holding the economy back."
But Smith's approach is simple. Treat the IOER (Interest on Excess Reserves) as the 'safe asset'. If it's less than the T-bill rate then the latter is the safe asset. Thus,
"The IROR is 0.25%. The T-bill rate is just over 0%. This means that the difference in the expected real rate of return between a world with an IROR and a world without an IROR is about 0.25%. In a world without an IROR, banks lend to any risky project with an expected real rate of return of S. In a world with an IROR, banks lend to any risky project with an expected real rate of return of S + 0.25%"
What he means in terms of Feldstein's claim, is that the band between a project's real rate of return and the +0.25% IOER has a lot of activity (projects to lend for) - R<project<R+0.25%
Basically it is, as Feldstein tries to assert, this that is holding back the excess reserves. If that spread disappeared and the 'safe asset rate' decreased by 0.25% (IOER), the reserves would flood the economy like chimera and inflation would finally bite, forget bark.
So where does the answer lie?
It's true, and it makes sense both on the surface as well as with a bit more thought. Otherwise, the moment the Fed cuts the IOER (stops paying interest on excess reserves), all hell will break loose. I'm pretty sure that's not happening.
And of course, it never hurts to look at Japan.
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