Best Banking: Animal Analogy Ever
Arcane banking regulations matter, but it’s hard to communicate anything about them to a broader audience. Alex Tabarrok rises to the occasion with an elegant analogy:
When no interest was paid on reserves banks tried to hold as few as
possible. But during the day the banks needed reserves – of which
there were only $40 billion or so – to fund trillions of
dollars worth of intraday payments. As
a result, there was typically a daily shortage of reserves which the
Fed made up for by extending hundreds of billions of dollars worth of
daylight credit. Thus, in essence, the banks used to inhale credit
during the day – puffing up like a bullfrog – only to exhale at night.
Alex is the only economist I know of who has highlighted the connection between the Fed’s new policy of paying interest on reserves, and the apparent evidence of a liquidity trap. Yet another reason why the world should listen to him.