An unprecedented number of commercial bank reserves ($1.4 trillion) continue to sit idle at US Federal Reserve banks. This raises a number of questions. Why does the Fed pay an interest on these reserves? Would it benefit the economy to eliminate this interest? To what extent do these reserves explain the “credit crunch” and/or “great recession”?
Speaking in the general vicinity of these questions, Aaron Edlin and Dwight Jaffee, both at Berkeley, in this article from March 2009, detail the unprecedented nature of the excess reserves (link). An excerpt:
Remember the massive credit crunch in August 2007 when the subprime crisis first be- came apparent to the world? At that time, real estate investors said their business had shut down overnight, and you can see the effects in the reserve numbers. Banks were so nervous then that excess reserves tripled from $1.6 billion in July 2007 to $4.8 billion in August 2007. Impressive to be sure. But nothing com- pared to now: even after tumbling in February, excess reserves were a whopping $650 billion at month end. Thars the problem folks. Or if not the problem, one heckuva symptom.
The Federal Reserve makes these figures available since 1959 on the web. Before 2007, the highest excess reserves ever got as a percent- age of required reserves was 50%. Now excess reserves are 1300% of required reserves. To ap- preciate the enormity of these reserves (and the fear that must be causing them), consider that the 50% number was from September, 2001, and you can bet dollars to donuts that was from fear caused by September 11. If we exclude Sep- tember 2001, then the highest excess reserves ever got pre-2007 was 7% of required reserves.