- [Instructor] What we're gonna do in this video
is talk about some interesting things
that have happened since 2008, and in particular,
we're gonna talk about what an ample reserves regime is,
but even more importantly, what its actual implications are
and how you can analyze it with a graph like this.
So let's just make sure we have our bearings first.
So the horizontal axis right over here is reserve balances,
and then the vertical axis here is interest rates.
So for the first part of this discussion,
let's ignore everything that we see in gray over here.
That's what we're gonna talk about
when we talk about the ample reserves regimes.
Let's say we're talking about a period pre-2008.
And in that situation,
you could imagine the more reserve balances you have,
the lower the demand is for reserve balances,
because if more banks are sitting on reserves,
well, then they don't need to go into the market
and borrow reserves as much.
And so what you would naturally expect
is as reserve balances increase, demand goes down
and of course, the actual interest
that people would need to pay in order to get reserves
if they're running low would go down.
So, for example, let's ignore this red line here.
Let's imagine a pre-2008 scenario where the actual reserves,
the supply of reserves looks like this.
And of course, the Federal Reserve can determine this
by printing money, increasing its balance sheet
or contracting its balance sheet.
They can do that as they see fit.
So in this situation right over here,
these are the total reserves that are in the system
that the Federal Reserve can decide.
And you have now a market rate for overnight reserves.
So if a bank is running low,
let's say they had a lot of withdrawals,
they need to meet their reserve requirements back then,
well, then they would go into the, quote, money market
and they would borrow some of that money from a bank
that has excess reserves.
Now, you might be wondering,
why does this curve, this blue curve flatten out
as you go further and further to the left?
Why doesn't it do something like this?
If the reserve balances are lower, and lower, lower,
you'd think people would charge higher
and higher interest rates to land reserves overnight.
Well, what puts a cap on this is the discount window.
This primary credit rate, this is the rate
that a bank in good standing, a strong bank,
you also have a secondary credit rate
for slightly weaker bank, that would be a higher rate,
but this is essentially
what banks can go to the Federal Reserve
and borrow directly from the Federal Reserve
at the discount window.
So that discount window rate right over here,
that essentially puts a cap on the overnight borrowing rate,
a cap on the rate that a bank would have to pay
in order to borrow reserves.
And so that's why you see the curve
essentially gets limited by that.
But now let's think about what happened in 2008,
and to understand that, I always get a kick
out of looking at the total assets of the Federal Reserve.
This is essentially the Federal Reserve's balance sheet.
You can view this as how much base money
they have put into circulation.
And I know these numbers are hard to read,
so let me write it down for you.
Out here, that is 2008, 2008.
And the rightmost point,
we are about three fourths of the way
through 2023 over here.
Now, you see something interesting happening
essentially a little bit midway through 2008.
The balance sheet increases significantly.
We go from roughly 1 trillion of base money
to $2 trillion of base money.
So essentially what the Federal Reserve was doing,
they were taking this vertical line
and they were pushing it far to the right over here.
Now, you might think historically why were they doing that.
Well, some of you might remember, we had banks failing.
It had a financial crisis.
They wanted to shore up not just the banking system,
but also the economy.
So the Federal Reserve just started printing money,
and it put us into a new territory,
a territory of ample reserves.
That's why it's called an ample reserves regime.
Now, there's an interesting question, though.
If you go to a situation of ample reserves,
and that's essentially the situation
that we could imagine right over here,
well, if you just had your traditional demand curve here,
this curve would've just kept going down and down and down.
And essentially there's so much reserves in the system
that the demand would go so low
that if a bank had access reserves,
it would pretty much get little to no interest
on those reserves.
Now, that's a tough situation in and of itself
because some of those banks needed that interest on reserves
because, once again, they were all in a tough situation.
And also, you want a situation
where banks could probably attract some depositors
by hopefully giving some interest
to the depositors themselves.
That also would strengthen the banking system.
So that's when in this ample reserves regime,
the Federal Reserve did something else.
They said, "Okay, banks, it is no longer the case
that the only way that you could get interest
on your reserves is by lending it to other banks.
We're going to allow you to take those reserves
and deposit them with us, with the Federal Reserve,
and we will give you interest on those reserves."
That's what this IOR is, interest on reserves.
And so if you are a banking institution,
this essentially set up a floor on the interest
that you would get on your reserves.
Now, the question you might be wondering is,
why doesn't this blue line then
just flatten out right over there?
And in some more simplified diagrams,
you will actually see that.
But it turns out that banks are not the only participants
in the money market.
You have other people
who are potentially lending reserves to banks,
and they don't have access
to depositing their reserves with the Federal Reserve.
So that's not a floor on them.
The Federal Reserve introduced another rate.
I won't go into the details of what on RRP stands for.
These essentially repurchase agreements.
This is essentially the Federal Reserve giving interest
to non-banking institutions on reserves that they place
with the actual Federal Reserve.
So this places a hard floor, 'cause even those folks,
they would never wanna lend below this
because they could get that much interest
with the Federal Reserve.
Now, the next question you might be wondering is,
all right, if we are out here in this ample reserves regime,
traditionally the Federal Reserve could change
the federal funds rate, the target rate
by moving this red line to the left and the right.
If you're in a non-ample reserves regime,
if you move this red line to the left,
well, what's gonna happen?
You're going to essentially increase
the overnight borrowing rate,
and that would constrict the economy.
And if you move it to the right,
you're going to decrease the overnight borrowing rate,
and that would stimulate the economy.
If you're out here on the right side,
if you move this vertical red line to the right or the left,
it's not going to change the overnight borrowing rate
because you're essentially going to be hugging
this pretty flat blue line.
And things have gotten even more ample since 2008.
We went from roughly 1 trillion to 2 trillion,
and then out here we are getting, approaching 8, 9 trillion.
And you might say, "Well, what happened right over here?"
Well, that was the COVID pandemic, where, once again,
the Federal Reserve really wanted to stimulate the economy,
and they did that by printing a ton of money.
So in the scenario that we've been in for a while now,
we are deep into an ample reserves regime.
If we were in ample reserves in 2008,
we're that much further right now in the 2020s.
So how does the Federal Reserve
actually control interest rates now?
Well, what they can do is they can control these floors,
or you could say this floor right over here.
If they want to increase interest rates,
they just increase the interest on reserves they give.
And if they do that,
then the curve will look something like this,
and then the overnight borrowing rate will be higher,
and then, of course, that would be restrictive
for the economy, and if they wanna loosen,
they can likewise lower the interest on reserves.