Double Or Nothing

Movement in the excess reserve rate could mean a major increase in income.

 
 

The current fed funds rate policy is usually referred to as a 0% rate policy, but the Fed has a target rate zone not a target rate. For decades, the Fed set a rate and an obliging market held to that single rate. Bernanke changed that in 2008 when he set a target rate zone of 0.0%-0.25%. The average effective funds rate for the past almost seven years has been 0.13%. A bank system awash in reserves coupled with a lack of demand has kept the funds rate at about half of the upper limit. Most importantly, the Fed has left the excess reserve rate at 0.25%. There is no need for the funds market as a place to invest overnight cash.

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The Fed has said nothing about the excess reserve rate, and it will likely move to 0.50%. For those of you with a lot of cash in excess reserves, that will double the income you are earning.

But, the Fed does not have to move that rate. In fact, the Fed does not have to pay anything at all on excess reserves.

If the Fed leaves the reserve rate unchanged, your income on cash will not increase at all. As the incentive to keep excess reserves evaporates, money will flow out of reserves and into the funds market. This will keep the funds rate at the low end of the target zone, perhaps near the bottom, which might actually be a relief to this Fed that seems to fear a rate increase.

What does this mean for you? If you are forecasting income based on a steady reserve rate that matches the top end of the target zone for fed funds, you should still use the top end of the new range. But, you might want to run a shadow income forecast assuming no increase in the return on cash. Double or nothing.    

Dwight Johnston is the chief economist of the California and Nevada Credit Union Leagues and president of Dwight Johnston Economics. He is the author of a popular commentary site and is a frequent speaker at credit union board planning sessions and industry conferences.

 
 

Nov. 19, 2015


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