Yesterday, the US FED announced its intentions to buy the long-dated US Treasuries, after a gap of nearly four decades. The Treasuries rallied exuberantly after the decision. (Last week, we in India, worried about the volatility of Government of India Bonds yields going through roof. Now, US Treasuries have joined the bond yield volatility party. Welcome to the club.)
The question is, will the action of buying of Treasuries and all the other assorted assets by FED help the economy, by itself, or does USA needs something else?
The answer lies in the chart below.
The question is, will the action of buying of Treasuries and all the other assorted assets by FED help the economy, by itself, or does USA needs something else?
The answer lies in the chart below.
This chart shows the balances held by commercial banks with FED. Clearly, after Sept 2008, the commercial banks have stacked up their cash with FED. Why do they need to keep cash with FED, at nearly zero yield? Clearly, the only logical reason, in normal times, is to manage transaction flows. However, these are not normal times. Banks are piling up the cash with FED as they do not want to lend to anybody else, be it corporate or another bank.
So, if FED buys more bonds from market, the banks will keep more money with FED. The net effect will be zilch.
What’s the solution? Simple. Charge banks “Safe-Keeping Charges” (SKC). FED should say that banks will be allowed to keep funds up to maximum of 0.10% of their liabilities overnight with FED without any charges. These balances are kept for transaction purpose. For any additional funds parked with FED, FED should charge 7.5% per annum SKC.
What is the logic of SKC at 7.50%. The logic flows from Taylor Rule, which suggests that the current interest rates in USA must be negative in the range of -3% to -8%, depending on what assumptions you put into the model. At 7.50% SKC, banks will face -7.50% per annum interest rate for their excess cash.
This can get credit flow in the US economy kick-started even without further buying of treasuries or agency bonds by FED, as banks themselves will go and buy these & other instruments.
So, if FED buys more bonds from market, the banks will keep more money with FED. The net effect will be zilch.
What’s the solution? Simple. Charge banks “Safe-Keeping Charges” (SKC). FED should say that banks will be allowed to keep funds up to maximum of 0.10% of their liabilities overnight with FED without any charges. These balances are kept for transaction purpose. For any additional funds parked with FED, FED should charge 7.5% per annum SKC.
What is the logic of SKC at 7.50%. The logic flows from Taylor Rule, which suggests that the current interest rates in USA must be negative in the range of -3% to -8%, depending on what assumptions you put into the model. At 7.50% SKC, banks will face -7.50% per annum interest rate for their excess cash.
This can get credit flow in the US economy kick-started even without further buying of treasuries or agency bonds by FED, as banks themselves will go and buy these & other instruments.
