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Excess reserves

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One of the criticisms heard today about banks is that they have available money to lend but they’re just not making loans with this money. Critics say if those funds were loaned, there would be a burst of economic activity. How valid is this criticism? N.C. State University economist Mike Walden responds.

“This is an important point. … The federal government, particularly the Federal Reserve, has created a large amount of money over the last … two or three years. They have funneled that money into the banking system, which is traditionally what they want to do. They do — and with the idea that banks will, therefore, have more money to loan to you and me and others and will spend that and that spending will create sales for businesses and cause businesses to hire more people.

“That’s the theory behind it. What we have not seen, however, is that actually taking place, because the banks collectively have decided not to loan a large amount of those so-called excess reserves that the Federal Reserve has given them.

“In fact $1.6 trillion of excess reserves essentially … is sitting in the vaults of … banks. Now the banks will respond and say, ‘Well, we will make loans if we think that they’re qualified loans out there to … be made.’ Also, the banks can turn around and invest those excess reserves with the Federal Reserve and earn, although a small rate of interest, at least some rate of interest.

“So … this is an issue. And one … corollary to it, however, is that those folks who worry about inflation say that, well, if … the banks released, if you will, that $1.6 trillion and sort of flooded the economy with it in terms of loans and new spending, that could dramatically increase inflation — at least in the short run.

“So, we’re in a quandary here, where we would like to see the banks loan more money, but we wouldn’t want to see them loan it all at once, because we do have that inflation issue also to worry about.”

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