Super interesting. This bit of news came out in time to make it into my presentation on monetary policy, the main thrust of which is that quantitative easing and interest payments on those newly created reserves will become conventional monetary policy.

Long story short (ok it's still long), QE was a method of bringing down long-term interest rates when nominal short-term rates were already near zero. Saved the economy? The Fed certainly thinks so, and the argument is coherent (bring down cost of borrowing, spur investment, recover, etc.). So all the trillions of dollars in bonds and mortgage-backed securities banks were holding the Fed purchased with (digitally summoned from thin air) money. But trillions of dollars entering circulation would lead to hyperinflation, so the Fed incentivized banks not to lend this new money out. How did they do that? Simple: They killed the Batman, er, the Fed started paying banks interest on their reserves. The rate was quite low: .25% between 2008 and 2016. But .25% interest on an amount that fluctuates between $1 and $2 trillion is still quite a lot. By my math, interest payments to banks grew gradually from $2 billion to $11 billion by 2016. Then $25 billion in 2017. It'll hit something like $50 billion by the end of 2019.

I'm tempted to expand the tangential point that these interest payments are a de facto subsidy of the banking industry. That of the 6,800 banks in the US, the top 25 institutions get half these payments. That a third of interest payments on reserves go to foreign own institutions. But I'm not an economist (yet).

Controlling inflation is an obvious function of paying IOR (interest on reserves). But the Fed still has to achieve its monetary goals and promote "maximum employment." And its conventional instrument--targeting a federal funds rate by manipulating the supply of reserves through open market operations--requires a scarcity of excess reserves. Now they're not so scarce. But there's another important benchmark interest rate that the Fed can set: the rate of interest it pays on reserves. Raise that rate and banks will park more of their money in reserve, restricting the money supply, and discourage lending, or lower it and get the opposite effects.

My conclusion was that this may be the new, "conventional" policy instrument. Even though the Fed started "normalizing" its balance sheet in September 2017 by selling more of its bond holdings, this process will almost certainly not finish before the next recession. And if it's a particularly bad recession, with nominal rates (i.e. IOR-rate) pretty low at 2.25%, there's not a lot of room to wiggle room. I can't imagine the Fed standing by idly, and so may well do more QE and, for the reasons explained above, continue to pay interest on reserves.

This yield curve inversion bolstered my point that a recession is a-comin'.