Banks have been dinged for their stingy attitude towards lending — it’s bizarre since they’re also still taking flack for having been too loose up until recently. Everyone assumes that we need to see more lending to get the economy going again, but what if the effects weren’t what we anticipated.
Robert Higgs at the Independent Institute notes the massive spike in excess bank reserves, from $2 billion to $559 billion, and wonders what happens once that money finds its way back into the real world:
At matters now stand, by far the greater threat is rapid inflation, notwithstanding the ongoing recession. When the banks begin to feel more comfortable with expanding the volume of their conventional loans and investments, they will have more than $550 billion on hand to employ for that purpose. The multiplied effect of such a vast amount of lending, as newly created deposits make their way through the fractional-reserve banking system, portends a gargantuan increase in the money stock and hence a correspondingly enormous jump in the general price level. As the public responds to the acceleration of inflation by reducing its demand for cash balances, the increased velocity of monetary circulation will contribute to even more rapid price inflation.
So much potential new money is now impounded in the commercial banks’ holdings of excess reserves that it is difficult to see how the Fed will be able to stem the flood once the banks begin to transform those excess reserves into normal loans and investments. If the Fed attempts to sell enough government securities to soak up the growing money stock, it will drive down the prices of Treasury bonds and hence drive up their yield, increasing the government’s cost of borrowing to finance the huge budget deficits the government will be running because of its various bailout commitments and so-called stimulus programs. This scenario holds the potential for a complete monetary crackup.