J. Bradford DeLong, Professor of Economics at the University of California, Berkeley, is a research associate at the National Bureau of Economic Research and the author of Slouching Towards Utopia: An Economic History of the Twentieth Century (Basic Books, 2022). He was Deputy Assistant US Treasury Secretary during the Clinton Administration, where he was heavily involved in budget and trade negotiations. His role in designing the bailout of Mexico during the 1994 peso crisis placed him at the forefront of Latin America’s transformation into a region of open economies, and cemented his stature as a leading voice in economic-policy debates.
Every week more liquidity is injected into the global banking system by the United States Federal Reserve and the European Central Bank. The average interest rate paid for overnight reserves in the US has been well below the 5.25% per year that the Fed still publicly says is its target.
But the market for overnight reserves now appears to be divided into three segments. Banks known to be healthy can borrow at much less than 5.25%. But banks facing possible liquidity problems – which the Fed wants to be able to borrow at 5.25% – are borrowing from the Fed itself at 5.75%, as are a few big banks that want more liquidity but don’t believe they could get it without disrupting the market.
Such a difference in the prices charged to “regulated banks” in financial markets is a sign of a potential breakdown. To date, the premiums charged are small: for an overnight loan of $100 million, even a one-percentage-point spread in the interest rate is only $3000. That reflects the small probability that the market is assigning to the occurrence of a full-blown financial crisis with bankruptcies and bank failures. In normal times, however, there is no such premium at all.
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