Bank lending decreased when the Fed switched to the floor system
In 2008, the Federal Reserve went from an operating system in which monetary policy was transmitted through open market operations (the corridor system) to one in which it is transmitted through the IOER rate (the floor system).
The Fed’s floor system, in short, has caused banks to increase their investment in the Fed at the expense of investing in the private sector. The question, then, becomes whether the Fed is any better than banks in allocating this credit. Put differently, is the Fed as a financial intermediary–funding short and lending long–really providing a better financial service than would have been provided by the private sector financial firms? It is not obvious to me that the answer is yes.
The Great Divorce: The FED’s Move to a Floor System and the Implications for Bank Portfolios
Author: David Beckworth
From: George Mason University
…no it didn’t!
I do not believe that a floor system inherently discourages bank lending as some critics appear to be arguing. Now that the Fed is paying IOR, reserves are essentially viewed by banks as an alternative form of interest-bearing government debt. New regulations since the crisis have induced banks to load up on safe government assets. But as the following figure shows, this has not come at the expense of private lending.
Does the Floor System Discourage Bank Lending?
By: David Andolfatto – Federal Reserve Bank of St. Louis
