The effect of tying open market policy to a FFR target is to supply additional (and excessive) legal reserves to the banking System when loan demand increases.

Since the member depository institutions have no excess reserves of significance, the banks have to acquire additional reserves (to support the expansion of deposits), resulting from their loan expansion (excess reserves are reserves in excess of a bank’s requirements, i.e., reserves in excess of the sum obtained by multiplying deposit liabilities by the appropriate reserve ratios).

With the use of the bracket device the Fed since 1965 has actually pursued a policy of automatic accommodation. That is, additional reserves and excess reserves were made available to the banking System whenever the bankers & their customers saw an advantage in expanding loans.

If the aggregate of bank bids for Federal Funds pushed the rate above the bracket set by the “trading desk” this would automatically trigger buy orders, which then ultimately led to an excessive volume of (1) Open Market Purchases, (2) Reserve Bank Credit, and (3) Legal Reserves. Soon a multiple volume of money is created on the basis of any given increase in legal reserves.

“Policy rules” are ex-post, (e.g, Taylor Rule). As applied, ‘true ups”, are necessarily lagging and staggered. In contrast, monetary flows (MVt), as defined, are ex-ante. With minor exceptions, forecasts are infallible.

The Fed, though intended to be an “independent” agency has, like the Supreme Court, “followed the elections”. We don’t have captialism, we have regulated capitalism.

We have an “elastic” currency “aided and abetted” by “elastic” legislators. We have perennial Walter Wriston caricatures pressuring the House Committee on Financial Services & the U.S. Senate Committee on Banking, Housing, and Urban Affairs. We have a conspiratorial organization that goes by the name of the American Bankers Association – with its well funded lobbyists (PAC money).

The Board of Governors is self-described as: “subject to oversight by Congress, which periodically reviews its activities and can alter its responsibilities by statute” Even so, the Fed is “connected at the hip” with Congressional allies, a la Greenspan, who the New York Times called a “three-card maestro”.

The Fed’s research is politically coordinated, targeted to justify its monetary policy objectives – those that appease the banking community. It’s as the university professor said: “innovate away from home”. Academic freedom has become the “barbarous relic”.

The great German poet and playwright Bertolt Brecht would have agreed and once said it was “easier to rob by setting up a bank than by holding up (one).”

The profit proclivities of the American Banker are responsible for our speculative orgy.

Regulation?? The conspiratorial titans, among other innovations, guaranteed the elimination of REG Q ceilings. It was a pyrrhic victory. Commercial banks compete for deposits by out-bidding their competition. But all of these deposits come from other commercial banks within the System.

I.e., the commercial banks cannot expand unless the FED decides to increase the money supply. However, the thrifts do compete for loan-funds. But even when they do, they cannot take money away from the commercial bankers.

The net of it is, lending by CBs is inflationary, lending by non-banks is not. And money flowing to the non-banks actually never leaves the CB System as anyone who has applied double-entry bookkeeping on a national scale should know.

So why should commercial bankers pay for something they already have? – interest on their deposits (REG Q in reverse). They would be much more competitive, and much more profitable, if they did not.

I’m more of the view that rates should scale for individual concerns and their specific exposures _as well as_ for the economy as a whole. Private capital is supposed to do this scaling now, as a risk premium among other things—but has conspicuously failed in this ‘quasi-regulatory’ function. The idea of scaling reserve requirements for individual firms is well-taken and needs to be applied, ahh, firmly, but scaling rates at the concern-level of the economy needs some degree of mandates. The key here, to me, is to start very small and then scale up with such regulatory constaints so as not to suddenly crush the life out of investing institutions by hard, tight collars. Such ideas need close consideration, but we don’t have to have a Central Regulator sitting in a bunker pushing buttons to command-optimize; such a result would be terrible regardless because inflexible. If concerns know that their personal rates-and-reserves will scale, and where the passive, mandated triggers are, they will plan accordingly. And any such passive, mandated quantitative triggers need to roll off just as automatically as exposure, concentration, or duration of expansion ease also.

. . . We all need to do some better, close reasoning here. But be sure of this: the market WON’T do it for us. The don’t want any constraints, so we must act before they kill (the money) again.

We also need more counter cyclical tools. Those mentioned at the end of the VoxEU article are welcome, but the key is time-variance. I think that such tools should be trend active, threshold passive, like a thermocouple in a thermostat, or in fact like a margin call. I will speak a little bit toward this concept myself down the road. All ideas are welcome now, though.

The FED cannot control the banks now. Reserves are not binding. And the money supply can never be managed by any attempt to control the cost of credit.

Take as an example the payment of interest on reserves. Everyone is on the bandwagon. But this is nonsense. Commercial banks create new money when they lend or invest. So if you provide another dollar of reserves, the banks acquire another one hundred dollars of earning assets. I.e., the bankers get paid twice.

Then the treasury recaptures 97% of the interest on open market purchases added to SOMA. That obviously is no tax. The commercial banks can expand when the FOMC decides, not when the bankers decide. This is ludicrous and prejudiced.