0:00:00.270,0:00:01.920 - [Instructor] What we're[br]gonna do in this video 0:00:01.920,0:00:04.260 is talk about some interesting things 0:00:04.260,0:00:07.380 that have happened since[br]2008, and in particular, 0:00:07.380,0:00:12.060 we're gonna talk about what[br]an ample reserves regime is, 0:00:12.060,0:00:15.600 but even more importantly, what[br]its actual implications are 0:00:15.600,0:00:18.300 and how you can analyze[br]it with a graph like this. 0:00:18.300,0:00:20.820 So let's just make sure we[br]have our bearings first. 0:00:20.820,0:00:25.820 So the horizontal axis right[br]over here is reserve balances, 0:00:25.890,0:00:29.910 and then the vertical axis[br]here is interest rates. 0:00:29.910,0:00:32.010 So for the first part of this discussion, 0:00:32.010,0:00:35.640 let's ignore everything that[br]we see in gray over here. 0:00:35.640,0:00:36.720 That's what we're gonna talk about 0:00:36.720,0:00:39.180 when we talk about the[br]ample reserves regimes. 0:00:39.180,0:00:43.110 Let's say we're talking[br]about a period pre-2008. 0:00:43.110,0:00:44.880 And in that situation, 0:00:44.880,0:00:48.720 you could imagine the more[br]reserve balances you have, 0:00:48.720,0:00:52.350 the lower the demand is[br]for reserve balances, 0:00:52.350,0:00:54.960 because if more banks[br]are sitting on reserves, 0:00:54.960,0:00:58.950 well, then they don't[br]need to go into the market 0:00:58.950,0:01:01.140 and borrow reserves as much. 0:01:01.140,0:01:03.450 And so what you would naturally expect 0:01:03.450,0:01:08.130 is as reserve balances[br]increase, demand goes down 0:01:08.130,0:01:11.580 and of course, the actual interest 0:01:11.580,0:01:15.510 that people would need to[br]pay in order to get reserves 0:01:15.510,0:01:17.310 if they're running low would go down. 0:01:17.310,0:01:20.100 So, for example, let's[br]ignore this red line here. 0:01:20.100,0:01:25.100 Let's imagine a pre-2008 scenario[br]where the actual reserves, 0:01:25.770,0:01:28.440 the supply of reserves looks like this. 0:01:28.440,0:01:31.260 And of course, the Federal[br]Reserve can determine this 0:01:31.260,0:01:34.320 by printing money,[br]increasing its balance sheet 0:01:34.320,0:01:35.700 or contracting its balance sheet. 0:01:35.700,0:01:39.000 They can do that as they see fit. 0:01:39.000,0:01:40.680 So in this situation right over here, 0:01:40.680,0:01:43.710 these are the total reserves[br]that are in the system 0:01:43.710,0:01:45.660 that the Federal Reserve can decide. 0:01:45.660,0:01:50.660 And you have now a market[br]rate for overnight reserves. 0:01:51.270,0:01:52.710 So if a bank is running low, 0:01:52.710,0:01:54.120 let's say they had a lot of withdrawals, 0:01:54.120,0:01:56.730 they need to meet their[br]reserve requirements back then, 0:01:56.730,0:01:59.910 well, then they would go[br]into the, quote, money market 0:01:59.910,0:02:03.090 and they would borrow some[br]of that money from a bank 0:02:03.090,0:02:05.640 that has excess reserves. 0:02:05.640,0:02:06.810 Now, you might be wondering, 0:02:06.810,0:02:09.570 why does this curve, this[br]blue curve flatten out 0:02:09.570,0:02:11.640 as you go further and further to the left? 0:02:11.640,0:02:13.650 Why doesn't it do something like this? 0:02:13.650,0:02:16.200 If the reserve balances are[br]lower, and lower, lower, 0:02:16.200,0:02:17.670 you'd think people would charge higher 0:02:17.670,0:02:21.840 and higher interest rates[br]to land reserves overnight. 0:02:21.840,0:02:25.350 Well, what puts a cap on[br]this is the discount window. 0:02:25.350,0:02:27.420 This primary credit rate, this is the rate 0:02:27.420,0:02:30.240 that a bank in good[br]standing, a strong bank, 0:02:30.240,0:02:31.680 you also have a secondary credit rate 0:02:31.680,0:02:34.140 for slightly weaker bank,[br]that would be a higher rate, 0:02:34.140,0:02:35.220 but this is essentially 0:02:35.220,0:02:37.440 what banks can go to the Federal Reserve 0:02:37.440,0:02:39.690 and borrow directly[br]from the Federal Reserve 0:02:39.690,0:02:41.550 at the discount window. 0:02:41.550,0:02:44.250 So that discount window[br]rate right over here, 0:02:44.250,0:02:47.730 that essentially puts a cap on[br]the overnight borrowing rate, 0:02:47.730,0:02:50.790 a cap on the rate that[br]a bank would have to pay 0:02:50.790,0:02:52.380 in order to borrow reserves. 0:02:52.380,0:02:54.540 And so that's why you see the curve 0:02:54.540,0:02:57.360 essentially gets limited by that. 0:02:57.360,0:03:01.470 But now let's think about[br]what happened in 2008, 0:03:01.470,0:03:04.980 and to understand that,[br]I always get a kick 0:03:04.980,0:03:07.620 out of looking at the total[br]assets of the Federal Reserve. 0:03:07.620,0:03:10.350 This is essentially the Federal[br]Reserve's balance sheet. 0:03:10.350,0:03:12.600 You can view this as how much base money 0:03:12.600,0:03:14.430 they have put into circulation. 0:03:14.430,0:03:16.350 And I know these numbers are hard to read, 0:03:16.350,0:03:18.150 so let me write it down for you. 0:03:18.150,0:03:21.623 Out here, that is 2008, 2008. 0:03:23.790,0:03:26.280 And the rightmost point, 0:03:26.280,0:03:28.320 we are about three fourths of the way 0:03:28.320,0:03:33.120 through 2023 over here. 0:03:33.120,0:03:35.906 Now, you see something[br]interesting happening 0:03:35.906,0:03:40.906 essentially a little[br]bit midway through 2008. 0:03:41.130,0:03:43.710 The balance sheet increases significantly. 0:03:43.710,0:03:46.950 We go from roughly 1[br]trillion of base money 0:03:46.950,0:03:50.520 to $2 trillion of base money. 0:03:50.520,0:03:52.770 So essentially what the[br]Federal Reserve was doing, 0:03:52.770,0:03:54.750 they were taking this vertical line 0:03:54.750,0:03:58.020 and they were pushing it[br]far to the right over here. 0:03:58.020,0:04:00.900 Now, you might think historically[br]why were they doing that. 0:04:00.900,0:04:03.960 Well, some of you might[br]remember, we had banks failing. 0:04:03.960,0:04:05.700 It had a financial crisis. 0:04:05.700,0:04:08.790 They wanted to shore up not[br]just the banking system, 0:04:08.790,0:04:10.500 but also the economy. 0:04:10.500,0:04:13.650 So the Federal Reserve just[br]started printing money, 0:04:13.650,0:04:16.770 and it put us into a new territory, 0:04:16.770,0:04:19.710 a territory of ample reserves. 0:04:19.710,0:04:22.830 That's why it's called[br]an ample reserves regime. 0:04:22.830,0:04:24.810 Now, there's an interesting[br]question, though. 0:04:24.810,0:04:27.120 If you go to a situation[br]of ample reserves, 0:04:27.120,0:04:28.530 and that's essentially the situation 0:04:28.530,0:04:32.550 that we could imagine right over here, 0:04:32.550,0:04:35.430 well, if you just had your[br]traditional demand curve here, 0:04:35.430,0:04:38.370 this curve would've just kept[br]going down and down and down. 0:04:38.370,0:04:40.920 And essentially there's so[br]much reserves in the system 0:04:40.920,0:04:42.660 that the demand would go so low 0:04:42.660,0:04:44.340 that if a bank had access reserves, 0:04:44.340,0:04:46.530 it would pretty much get[br]little to no interest 0:04:46.530,0:04:48.150 on those reserves. 0:04:48.150,0:04:50.640 Now, that's a tough[br]situation in and of itself 0:04:50.640,0:04:53.220 because some of those banks[br]needed that interest on reserves 0:04:53.220,0:04:55.350 because, once again, they[br]were all in a tough situation. 0:04:55.350,0:04:56.820 And also, you want a situation 0:04:56.820,0:04:59.220 where banks could probably[br]attract some depositors 0:04:59.220,0:05:01.260 by hopefully giving some interest 0:05:01.260,0:05:03.150 to the depositors themselves. 0:05:03.150,0:05:05.730 That also would strengthen[br]the banking system. 0:05:05.730,0:05:08.940 So that's when in this[br]ample reserves regime, 0:05:08.940,0:05:11.100 the Federal Reserve did something else. 0:05:11.100,0:05:13.740 They said, "Okay, banks,[br]it is no longer the case 0:05:13.740,0:05:15.510 that the only way that[br]you could get interest 0:05:15.510,0:05:18.420 on your reserves is by[br]lending it to other banks. 0:05:18.420,0:05:21.090 We're going to allow you[br]to take those reserves 0:05:21.090,0:05:24.870 and deposit them with us,[br]with the Federal Reserve, 0:05:24.870,0:05:28.200 and we will give you[br]interest on those reserves." 0:05:28.200,0:05:31.890 That's what this IOR is,[br]interest on reserves. 0:05:31.890,0:05:35.280 And so if you are a banking institution, 0:05:35.280,0:05:39.360 this essentially set up[br]a floor on the interest 0:05:39.360,0:05:41.940 that you would get on your reserves. 0:05:41.940,0:05:44.460 Now, the question you[br]might be wondering is, 0:05:44.460,0:05:45.930 why doesn't this blue line then 0:05:45.930,0:05:48.210 just flatten out right over there? 0:05:48.210,0:05:50.580 And in some more simplified diagrams, 0:05:50.580,0:05:52.530 you will actually see that. 0:05:52.530,0:05:56.010 But it turns out that banks[br]are not the only participants 0:05:56.010,0:05:57.270 in the money market. 0:05:57.270,0:05:58.410 You have other people 0:05:58.410,0:06:00.780 who are potentially[br]lending reserves to banks, 0:06:00.780,0:06:02.520 and they don't have access 0:06:02.520,0:06:05.190 to depositing their reserves[br]with the Federal Reserve. 0:06:05.190,0:06:07.230 So that's not a floor on them. 0:06:07.230,0:06:09.300 The Federal Reserve[br]introduced another rate. 0:06:09.300,0:06:12.330 I won't go into the details[br]of what on RRP stands for. 0:06:12.330,0:06:14.490 These essentially repurchase agreements. 0:06:14.490,0:06:17.190 This is essentially the[br]Federal Reserve giving interest 0:06:17.190,0:06:21.840 to non-banking institutions[br]on reserves that they place 0:06:21.840,0:06:23.790 with the actual Federal Reserve. 0:06:23.790,0:06:27.960 So this places a hard floor,[br]'cause even those folks, 0:06:27.960,0:06:29.460 they would never wanna lend below this 0:06:29.460,0:06:31.230 because they could get that much interest 0:06:31.230,0:06:33.330 with the Federal Reserve. 0:06:33.330,0:06:35.520 Now, the next question[br]you might be wondering is, 0:06:35.520,0:06:39.990 all right, if we are out here[br]in this ample reserves regime, 0:06:39.990,0:06:43.260 traditionally the Federal[br]Reserve could change 0:06:43.260,0:06:45.570 the federal funds rate, the target rate 0:06:45.570,0:06:48.540 by moving this red line[br]to the left and the right. 0:06:48.540,0:06:51.180 If you're in a non-ample reserves regime, 0:06:51.180,0:06:54.690 if you move this red line to the left, 0:06:54.690,0:06:55.920 well, what's gonna happen? 0:06:55.920,0:06:57.960 You're going to essentially increase 0:06:57.960,0:06:59.910 the overnight borrowing rate, 0:06:59.910,0:07:02.400 and that would constrict the economy. 0:07:02.400,0:07:03.960 And if you move it to the right, 0:07:03.960,0:07:06.930 you're going to decrease the[br]overnight borrowing rate, 0:07:06.930,0:07:09.270 and that would stimulate the economy. 0:07:09.270,0:07:10.920 If you're out here on the right side, 0:07:10.920,0:07:14.220 if you move this vertical red[br]line to the right or the left, 0:07:14.220,0:07:16.680 it's not going to change[br]the overnight borrowing rate 0:07:16.680,0:07:18.120 because you're essentially[br]going to be hugging 0:07:18.120,0:07:20.670 this pretty flat blue line. 0:07:20.670,0:07:23.670 And things have gotten[br]even more ample since 2008. 0:07:23.670,0:07:26.250 We went from roughly 1[br]trillion to 2 trillion, 0:07:26.250,0:07:30.240 and then out here we are getting,[br]approaching 8, 9 trillion. 0:07:30.240,0:07:32.400 And you might say, "Well, what[br]happened right over here?" 0:07:32.400,0:07:35.430 Well, that was the COVID[br]pandemic, where, once again, 0:07:35.430,0:07:38.160 the Federal Reserve really[br]wanted to stimulate the economy, 0:07:38.160,0:07:41.580 and they did that by[br]printing a ton of money. 0:07:41.580,0:07:45.180 So in the scenario that we've[br]been in for a while now, 0:07:45.180,0:07:48.090 we are deep into an ample reserves regime. 0:07:48.090,0:07:50.070 If we were in ample reserves in 2008, 0:07:50.070,0:07:53.970 we're that much further[br]right now in the 2020s. 0:07:53.970,0:07:55.380 So how does the Federal Reserve 0:07:55.380,0:07:57.720 actually control interest rates now? 0:07:57.720,0:08:00.750 Well, what they can do is[br]they can control these floors, 0:08:00.750,0:08:02.940 or you could say this[br]floor right over here. 0:08:02.940,0:08:05.670 If they want to increase interest rates, 0:08:05.670,0:08:08.910 they just increase the[br]interest on reserves they give. 0:08:08.910,0:08:10.080 And if they do that, 0:08:10.080,0:08:13.200 then the curve will look[br]something like this, 0:08:13.200,0:08:15.720 and then the overnight[br]borrowing rate will be higher, 0:08:15.720,0:08:18.030 and then, of course,[br]that would be restrictive 0:08:18.030,0:08:20.340 for the economy, and if they wanna loosen, 0:08:20.340,0:08:24.123 they can likewise lower[br]the interest on reserves.