Short-term money and the Fed

The usual story for monetary policy effectiveness that if the Fed lowers the Fed funds rate there will be more bank lending through the money multiplier. If the cost of reserves is lowered, the volume of lending will go up. It was that simple. 

If the Fed funds is pushed to zero, the idea is that the Fed should crowd out investors in risk-free instruments and push them into riskier assets. Unfortunately, research suggests that the causation does not move from bank reserves to bank lending. In reality, bank lending decisions are made on the creditworthiness of the borrower and then tries to find the cheapest method of financing. 

Empirical analysis finds that changes in reserve balances are uncorrelated with movements in bank lending. This is not something new, the latest research reinforces the argument that there is not a text book link between lower rates, increasing reserves and seeing more lending. Reserves are way up,  the money multiplier has fallen and lending is not up.

Bank reserves have increases and the difference between Fed funds and IOER (interest rate on excess reserves) has gone more negative. The Fed funds market has fallen apart with loans only about 1/3rd of 2008 levels and half of 2005 levels. Bank reserves are increasing with rising bank capital requirements and deposit insurance assessments. Bank reserves have moved from close to zero in the pre-crisis environment to over $800 billion for large domestic banks and $1.2 trillion for foreign banks. Cash represents more than 50% of non-US bank assets and about 13% of large US bank assets. 

The Fed should have expected this result. If that is the case, then what will be the policy tool or action that will change bank lending? 

Not the difference in this post versus our comments on 'credit cassandras" where high yield syndicated loans are exploding in volume. There is money that is available for weak credits at high fees and relative prices, but normal lending is a very different matter. 

This is the policy issues the has to be discussed and addressed. Enough on forward guidance and tapering.