Saturday, January 3, 2015

Interest-paying money is not inflationary

(With credible fiscal policy, of course.)  Another interesting case, from JP Koning's Blog "Moneyness"

RBNZ decided to 'flood' the system with balances to make things more fluid. This involved conducting open market purchases that bloated the monetary base (comprised of currency plus deposits) from around NZ$6 billion in mid-2006 to just under NZ$14 billion by December of that year. See chart below. 
(Note that the RBNZ's problems began far before the credit crisis and were due entirely to the peculiar structure of the clearing system, not New Zealand's economy.)

Koning describes the lack of inflation as a result of the perceived "permanence" of the increased reserves. I think it comes from the fact that reserves pay interest -- as they do in New Zealand. Either way, the point is that banks and people are happy to sit on interest-paying money, in enormous quantities, just as they are on bonds.

The corresponding inflation and interest rates:

Source: Reserve Bank of New Zealand

Source: Reserve Bank of New Zealand


  1. "Konig describes the lack of inflation as a result of the perceived "permanence" of the increased reserves. I think it comes from the fact that reserves pay interest -- as they do in New Zealand."

    Whoops, it's Koning, not Konig. I also think the lack of inflation comes from paying interest -- maybe I didn't manage to convey that in my post.

  2. Trying to translate into language I am more familiar with, paying interest on reserves decreases the high-powered money multiplier. Yes?

  3. An interesting story. Clearing activities were inefficient and banks were using the loan privisions intended to supply capital for using those services. So, RBNZ fixed things by open market operations to flood the "system" with cash. Really? That is the fix for an inefficient clearing system? It seems like a cover story to me.

    Consider this story. The NZ government wanted more money to spend, but didn't want to sell more bonds if this would raise the official interest rate. So, RBNZ bought bonds from the banks as the NZGov sold them. RBNZ "sterilized" the extra cash by encouraging the banks to keep it as reserves at the RBNZ. This avoided inflating prices generally from circulation of the new cash. RBNZ offered interest on reserves held there, increasing the interest rate in 5bp increments until 25bp did the trick.

    In this story, RBNZ and NZGov found a way to monetize NZGov debt without increasing the bond debt outstanding or increasing inflation. Instead, the debt occurs on the RBNZ balance sheet.

    I am not an expert, and maybe too suspicious, but which story is more probable? I am open to being corrected.

  4. I am a slightly confused by your use of the term "sit on" settlement balances since I was under the impression that the net amount of such balances is fixed (except in the situation where they are taken out by banks as cash). After all, the only way a bank can obtain a lower balance if it makes a transfer (e.g. an interbank loan) to another bank, but then the other bank obtains a correspondingly higher balance.

    They also wrote about this at Economonitor where they make clear that banks don't "lend out reserves" []

  5. An interesting example. I was intrigued if there were any other examples. I had a look at Canada, but couldn't find any. So I had a look at New Zealand's northern neighbor. This is another very striking example that supports your point John:

    The reserve bank of Australia increased reserves roughly twenty fold over a fortnight. And this was in 2013, with no financial crisis in sight.

    I'm yet to hear of hyperinflation in Australia...


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