When I published Floored! last October, I thought I’d said all I could say concerning the adverse consequences of the Fed’s then decade-old decision to adopt a “floor”-type operating system. In the new arrangement, the Fed pays interest on bank reserves, and uses changes in the rate it pays, instead of adjustments to the available quantity of bank reserves, to regulate other interest rates. Among other things, I explain in my book, as I’ve also done to some extent here at Alt‑M, that decision contributed to the U.S. economy’s deep downturn in late 2008, that it undermined banks’ incentives to monitor each other’s safety, and that it has made it more tempting for politicians to treat the Fed as a giant piggy-bank to drawn upon for their pet trillion-dollar projects.
But it turns out I overlooked a serious shortcoming of the Fed’s floor system. Not that I’m kicking myself: I could hardly be blamed for overlooking a problem that wasn’t at all evident in the fall of 2018. But the problem has since become all-too obvious. I refer to the new operating system’s inability to get interest rates to go where it wants them to.