11 - The problem of excess reserves

Summary

Federal Reserve officials supply regulations to help banks. Although the information is difficult to find in Fed minutes, just ten banks hold almost all the excess reserves of the Fed system. These ten banks were in receipt of the new interest on excess reserves that the Fed decided to pay them from 2008.

Excess reserves are those reserves that are over and above what is required to be held at the Federal Reserve. Traditionally, banks had tried to keep the exact amount of required reserves, due at the Fed each week, with zero excess. From the second quarter of 1984 to the second quarter of 2008 excess reserves averaged $1.3 billion, a minimum that could be feasibly achieved.

Once the Fed began paying IOER, excess reserves averaged $1.75 trillion from the third quarter of 2008 to the third quarter of 2020. That is more than a thousand-fold increase, going from billions to trillions of dollars. This happened even though the interest rate paid was very low, and below the inflation rate.

Figure 11.1 shows how excess reserves quickly built up at the Fed, rising from zero to $2.7 trillion by the third quarter of 2014. They began to trend down after that, until rising again during the Covid-19 pandemic till the excess reserve data series ended in 2020. Since then these “excess” reserves are now just called reserves, and shot up to above $4 trillion in 2021.

The data series on excess reserves ends in September 2020, when the Fed changed its reserve requirement to zero. Therefore, reserves could no longer be called “excess reserves”, since a reserve requirement no longer existed. In addition, the Fed's name of “interest on excess reserves” was officially changed in July 2021 to “interest on reserve balances” (IORB).

The Fed had required reserves for banks for over a century, from 1914 until 2020, with a continual decline in the requirement evident as banks avoided it. Feinman (1993: 570) describes how depository banks had to keep 10 per cent of reserves on “transaction deposits” that were viewed as being subject to immediate demand: