WEBVTT

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- [Instructor] What we're
gonna do in this video

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is talk about some interesting things

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that have happened since
2008, and in particular,

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we're gonna talk about what
an ample reserves regime is,

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but even more importantly, what
its actual implications are

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and how you can analyze
it with a graph like this.

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So let's just make sure we
have our bearings first.

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So the horizontal axis right
over here is reserve balances,

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and then the vertical axis
here is interest rates.

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So for the first part of this discussion,

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let's ignore everything that
we see in gray over here.

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That's what we're gonna talk about

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when we talk about the
ample reserves regimes.

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Let's say we're talking
about a period pre-2008.

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And in that situation,

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you could imagine the more
reserve balances you have,

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the lower the demand is
for reserve balances,

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because if more banks
are sitting on reserves,

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well, then they don't
need to go into the market

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and borrow reserves as much.

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And so what you would naturally expect

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is as reserve balances
increase, demand goes down

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and of course, the actual interest

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that people would need to
pay in order to get reserves

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if they're running low would go down.

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So, for example, let's
ignore this red line here.

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Let's imagine a pre-2008 scenario
where the actual reserves,

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the supply of reserves looks like this.

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And of course, the Federal
Reserve can determine this

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by printing money,
increasing its balance sheet

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or contracting its balance sheet.

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They can do that as they see fit.

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So in this situation right over here,

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these are the total reserves
that are in the system

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that the Federal Reserve can decide.

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And you have now a market
rate for overnight reserves.

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So if a bank is running low,

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let's say they had a lot of withdrawals,

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they need to meet their
reserve requirements back then,

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well, then they would go
into the, quote, money market

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and they would borrow some
of that money from a bank

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that has excess reserves.

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Now, you might be wondering,

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why does this curve, this
blue curve flatten out

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as you go further and further to the left?

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Why doesn't it do something like this?

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If the reserve balances are
lower, and lower, lower,

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you'd think people would charge higher

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and higher interest rates
to land reserves overnight.

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Well, what puts a cap on
this is the discount window.

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This primary credit rate, this is the rate

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that a bank in good
standing, a strong bank,

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you also have a secondary credit rate

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for slightly weaker bank,
that would be a higher rate,

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but this is essentially

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what banks can go to the Federal Reserve

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and borrow directly
from the Federal Reserve

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at the discount window.

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So that discount window
rate right over here,

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that essentially puts a cap on
the overnight borrowing rate,

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a cap on the rate that
a bank would have to pay

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in order to borrow reserves.

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And so that's why you see the curve

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essentially gets limited by that.

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But now let's think about
what happened in 2008,

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and to understand that,
I always get a kick

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out of looking at the total
assets of the Federal Reserve.

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This is essentially the Federal
Reserve's balance sheet.

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You can view this as how much base money

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they have put into circulation.

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And I know these numbers are hard to read,

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so let me write it down for you.

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Out here, that is 2008, 2008.

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And the rightmost point,

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we are about three fourths of the way

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through 2023 over here.

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Now, you see something
interesting happening

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essentially a little
bit midway through 2008.

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The balance sheet increases significantly.

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We go from roughly 1
trillion of base money

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to $2 trillion of base money.

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So essentially what the
Federal Reserve was doing,

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they were taking this vertical line

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and they were pushing it
far to the right over here.

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Now, you might think historically
why were they doing that.

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Well, some of you might
remember, we had banks failing.

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It had a financial crisis.

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They wanted to shore up not
just the banking system,

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but also the economy.

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So the Federal Reserve just
started printing money,

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and it put us into a new territory,

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a territory of ample reserves.

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That's why it's called
an ample reserves regime.

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Now, there's an interesting
question, though.

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If you go to a situation
of ample reserves,

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and that's essentially the situation

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that we could imagine right over here,

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well, if you just had your
traditional demand curve here,

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this curve would've just kept
going down and down and down.

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And essentially there's so
much reserves in the system

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that the demand would go so low

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that if a bank had access reserves,

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it would pretty much get
little to no interest

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on those reserves.

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Now, that's a tough
situation in and of itself

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because some of those banks
needed that interest on reserves

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because, once again, they
were all in a tough situation.

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And also, you want a situation

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where banks could probably
attract some depositors

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by hopefully giving some interest

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to the depositors themselves.

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That also would strengthen
the banking system.

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So that's when in this
ample reserves regime,

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the Federal Reserve did something else.

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They said, "Okay, banks,
it is no longer the case

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that the only way that
you could get interest

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on your reserves is by
lending it to other banks.

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We're going to allow you
to take those reserves

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and deposit them with us,
with the Federal Reserve,

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and we will give you
interest on those reserves."

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That's what this IOR is,
interest on reserves.

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And so if you are a banking institution,

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this essentially set up
a floor on the interest

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that you would get on your reserves.

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Now, the question you
might be wondering is,

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why doesn't this blue line then

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just flatten out right over there?

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And in some more simplified diagrams,

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you will actually see that.

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But it turns out that banks
are not the only participants

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in the money market.

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You have other people

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who are potentially
lending reserves to banks,

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and they don't have access

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to depositing their reserves
with the Federal Reserve.

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So that's not a floor on them.

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The Federal Reserve
introduced another rate.

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I won't go into the details
of what on RRP stands for.

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These essentially repurchase agreements.

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This is essentially the
Federal Reserve giving interest

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to non-banking institutions
on reserves that they place

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with the actual Federal Reserve.

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So this places a hard floor,
'cause even those folks,

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they would never wanna lend below this

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because they could get that much interest

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with the Federal Reserve.

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Now, the next question
you might be wondering is,

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all right, if we are out here
in this ample reserves regime,

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traditionally the Federal
Reserve could change

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the federal funds rate, the target rate

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by moving this red line
to the left and the right.

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If you're in a non-ample reserves regime,

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if you move this red line to the left,

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well, what's gonna happen?

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You're going to essentially increase

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the overnight borrowing rate,

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and that would constrict the economy.

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And if you move it to the right,

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you're going to decrease the
overnight borrowing rate,

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and that would stimulate the economy.

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If you're out here on the right side,

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if you move this vertical red
line to the right or the left,

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it's not going to change
the overnight borrowing rate

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because you're essentially
going to be hugging

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this pretty flat blue line.

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And things have gotten
even more ample since 2008.

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We went from roughly 1
trillion to 2 trillion,

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and then out here we are getting,
approaching 8, 9 trillion.

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And you might say, "Well, what
happened right over here?"

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Well, that was the COVID
pandemic, where, once again,

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the Federal Reserve really
wanted to stimulate the economy,

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and they did that by
printing a ton of money.

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So in the scenario that we've
been in for a while now,

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we are deep into an ample reserves regime.

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If we were in ample reserves in 2008,

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we're that much further
right now in the 2020s.

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So how does the Federal Reserve

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actually control interest rates now?

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Well, what they can do is
they can control these floors,

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or you could say this
floor right over here.

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If they want to increase interest rates,

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they just increase the
interest on reserves they give.

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And if they do that,

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then the curve will look
something like this,

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and then the overnight
borrowing rate will be higher,

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and then, of course,
that would be restrictive

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for the economy, and if they wanna loosen,

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they can likewise lower
the interest on reserves.