<p>Axel Leijonhufvud said...</p>
<blockquote>
<p>The Fed is supplying the banks with reserves at a near-zero rate.</p>
</blockquote>
<p>The bank reserves are in part funded by deposits in transaction accounts and savings accounts. <a href="https://en.wikipedia.org/wiki/Transaction_account" rel="nofollow noreferrer">The Wikipedia article on transaction accounts</a> says...</p>
<blockquote>
<p>The Dodd-Frank Wall Street Reform and Consumer Protection Act,
however, passed by Congress and signed into law by President Obama on
July 21, 2010, repealed the statutes that prohibit interest-bearing
demand deposit accounts, effectively repealing Regulation Q (Pub. L.
111-203, Section 627). The repeal took effect on July 21, 2011. Since
that date, financial institutions have been permitted, but not
required, to offer interest-bearing demand deposit accounts.</p>
</blockquote>
<p>So the repeal happened a few months after the Leijonhufvud article. Regardless, there were savings accounts which have long paid interest.  Surely a retired person can diversify between a transaction account and a savings account so that person would have been earning some interest even before the repeal and for any investor with significant funds, typically only a minority of holdings would be transactional.</p>
<p>Yet Leijonhufvud lamented...</p>
<blockquote>
<p>&quot;transfers from tax-payers as well as from the mostly aged savers who
cannot find alternative safe placements for their funds in retirement&quot;</p>
</blockquote>
<p>I am assuming that in Leijonhufvud's view, even the savings account rate was low enough to be one reason for his concern that there existed a subsidy.</p>
<p>A low interest rate on a savings account deposit is not directly determined by the Fed. Banks would like to pay depositors less but competition between banks can force that rate higher. The reason competition does not force that rate higher is because in an economy that the Fed thinks requires stimulus, such as in 2011, households and businesses are more risk averse than usual so they allocate less to risky holdings and more to low risk holdings like deposits.</p>
<p>A side matter... If there is inadequate competition, that is a different subject. The Leijonhufvud article does not seem to be blaming a lack of competition.</p>

CC BY-SA 4.0
2022-02-21T04:39:54.880Z
2022-02-21T06:39:30.117Z
2022-02-21T06:39:30.117Z
H2ONaCl
<p>To my best knowledge there is no research directly examining this question empirically for the United States banking sector, although it’s possible I might have missed something in which case I hope some other answer answers it.</p>
<p>As a consequence I don’t see any way how there could be significant consensus on the matter. Nonetheless, there is some indirect evidence.There is actually quite a lot of research on relationship between monetary policy and bank profitability.</p>
<p>For example, <a href="https://onlinelibrary.wiley.com/doi/full/10.1111/infi.12104?casa_token=luC2reyU3R8AAAAA%3AlHyltyXsEQuRIr2A2PNN9G5XCOeG__gf4eMq6_z9WjEgcNMFmWpbLwDqdHiOp0QJtivwYV9Gw3ly2E0" rel="nofollow noreferrer">Borio et al (2017)</a>,  <a href="https://academic.oup.com/economicpolicy/article/33/96/531/5124289?login=true" rel="nofollow noreferrer">Altavilla (2018)</a> or specifically for US <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3395190" rel="nofollow noreferrer">Goodhart, &amp; Kabiri, (2019)</a> show that loose monetary policy reduces overall bank profitability. This in itself does not mean there is no implicit subsidy because maybe profitability falls despite implicit subsidy the banks get. However, this being said it’s not that common for business that get subsidized implicitly to experience lower profits, so at least you could consider this to be indirect evidence for it.</p>
<p>In addition, the mechanism mentioned in most of the papers for increase in profitability would be increase in demand for bank loans as opposed to some implicit subsidy by lowering the cost of funds.</p>
<p>Nonetheless, there is also some evidence from large panel of counties that shows that although bank profitability falls the spread between deposit and lending rates increases (<a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3322331" rel="nofollow noreferrer">Zimmermann 2019</a>). Hence, this could be perhaps viewed as evidence for banks being <em>implicitly</em> subsidized since it would lower their costs of funds while their prices do not fall enough to keep their margins constant. One could argue that would be an implicit subsidy.</p>
<p>On other hand there are also some good papers that claim that low interest rates do not negatively affect bank profitability such as <a href="https://www.ecb.europa.eu/pub/pdf/scpwps/ecb.wp2105.en.pdf" rel="nofollow noreferrer">Altavilla et al (2017)</a>. The argument goes that that once you better control for endogeneity and after some time (in a very short run the profits can still be negatively affected).</p>
<p>Also to be clear most of the evidence above is from either international set of countries or Europe. In principle there could be some heterogeneity.</p>
<p>As you can see above the evidence is mixed. Nonetheless, most studies find negative or no relationships. it is more rare to find positive relationships. Consequently, this can be interpreted as that either there aren’t implicit subsidies or if there are some they are too small to offset negative impact on profitability of low interest rates. Lastly to be clear if there are any subsidies they are implicit not explicit ones.</p>

CC BY-SA 4.0
2022-02-21T12:09:28.633Z
2022-02-21T12:09:28.633Z
1muflon1
<p>Axel Leijonhfvud (Professor Emeritus, Department of Economics, UCLA) <a href="https://voxeu.org/article/21st-century-shell-game-how-bankers-play-and-taxpayers-pay" rel="nofollow noreferrer">wrote</a> in 2011:</p>
<blockquote>
<p>The Fed is supplying the banks with reserves at a near-zero rate. Not much results in bank lending to business, but banks can buy Treasuries that pay 3% to 4%.</p>
<p>This hefty subsidy to the banking system is ultimately borne by taxpayers. Neither the subsidy, nor the tax liability has been voted for by Congress.</p>
</blockquote>
<p>This was <a href="https://economistsview.typepad.com/economistsview/2011/01/zero-interest-policies-as-hidden-subsidies-to-banks.html#comments" rel="nofollow noreferrer">reposted</a> by Mark Thoma (Professor of Economics, University of Oregon). However, Paul Krugman (Distinguished Professor, CUNY), who writes for the NYTimes, <a href="https://krugman.blogs.nytimes.com/2011/01/25/are-low-rates-a-subsidy-to-banks/" rel="nofollow noreferrer">argued</a> that there is no subsidy.</p>
<p>Is there a consensus on this issue today (11 years later)?</p>

CC BY-SA 4.0
2022-02-19T13:29:12.620Z
Krugman's argument is that the long rates reflect uncertainty about the future short rates. One might wonder if everyone is uncertain. If I have influence over who becomes the Fed chairman, and I know that he will keep the rates near 0, are they a subsidy **to me**?
MWB
CC BY-SA 4.0
2022-02-20T17:54:09.547Z
I don't have enough data to be certain, but anecdotally it seems to me that most qualified economists accept that this is not a subsidy.  After all, any investor can buy Treasuries at the market yield.  Also, it is evident that banks in fact do better when rates are higher (witness the correlation between higher rates and bank stock prices, due to the fact that when rates are zero, banks can't pay you less than that on your savings account).
dm63
CC BY-SA 4.0
2022-02-21T04:48:00.127Z
@dm63 Leijonhfvud is contrasting short duration deposits and long duration Treasury bonds. When you say "rates" do you mean long duration or short? Please clarify .
H2ONaCl
CC BY-SA 4.0
2022-02-21T15:39:44.720Z
by 'rates' i meant short term rates
dm63
<inflation><monetary-policy><federal-reserve><fed-funds-rate>
Are low rates a subsidy to banks?
MWB
# Are low rates a subsidy to banks?

(Asked by: username_0 on 2022-02-19)

Axel Leijonhfvud (Professor Emeritus, Department of Economics, UCLA) [wrote](https://voxeu.org/article/21st-century-shell-game-how-bankers-play-and-taxpayers-pay) in 2011:

> The Fed is supplying the banks with reserves at a near-zero rate. Not much results in bank lending to business, but banks can buy Treasuries that pay 3% to 4%.
>
> This hefty subsidy to the banking system is ultimately borne by taxpayers. Neither the subsidy, nor the tax liability has been voted for by Congress.

This was [reposted](https://economistsview.typepad.com/economistsview/2011/01/zero-interest-policies-as-hidden-subsidies-to-banks.html#comments) by Mark Thoma (Professor of Economics, University of Oregon). However, Paul Krugman (Distinguished Professor, CUNY), who writes for the NYTimes, [argued](https://krugman.blogs.nytimes.com/2011/01/25/are-low-rates-a-subsidy-to-banks/) that there is no subsidy.

Is there a consensus on this issue today (11 years later)?

**Tags:** inflation, monetary-policy, federal-reserve, fed-funds-rate
> **Comments:**
> **username_0**: Krugman's argument is that the long rates reflect uncertainty about the future short rates. One might wonder if everyone is uncertain. If I have influence over who becomes the Fed chairman, and I know that he will keep the rates near 0, are they a subsidy **to me**?  
> **username_1**: I don't have enough data to be certain, but anecdotally it seems to me that most qualified economists accept that this is not a subsidy.  After all, any investor can buy Treasuries at the market yield.  Also, it is evident that banks in fact do better when rates are higher (witness the correlation between higher rates and bank stock prices, due to the fact that when rates are zero, banks can't pay you less than that on your savings account).  
> **username_2**: @dm63 Leijonhfvud is contrasting short duration deposits and long duration Treasury bonds. When you say "rates" do you mean long duration or short? Please clarify .  
> **username_1**: by 'rates' i meant short term rates  

---

## 2 answers

### Answer by username_2 on 2022-02-21. Score: 2

Axel Leijonhufvud said...

> The Fed is supplying the banks with reserves at a near-zero rate.

The bank reserves are in part funded by deposits in transaction accounts and savings accounts. [The Wikipedia article on transaction accounts](https://en.wikipedia.org/wiki/Transaction_account) says...

> The Dodd-Frank Wall Street Reform and Consumer Protection Act,
> however, passed by Congress and signed into law by President Obama on
> July 21, 2010, repealed the statutes that prohibit interest-bearing
> demand deposit accounts, effectively repealing Regulation Q (Pub. L.
> 111-203, Section 627). The repeal took effect on July 21, 2011. Since
> that date, financial institutions have been permitted, but not
> required, to offer interest-bearing demand deposit accounts.

So the repeal happened a few months after the Leijonhufvud article. Regardless, there were savings accounts which have long paid interest. Surely a retired person can diversify between a transaction account and a savings account so that person would have been earning some interest even before the repeal and for any investor with significant funds, typically only a minority of holdings would be transactional.

Yet Leijonhufvud lamented...

> "transfers from tax-payers as well as from the mostly aged savers who
> cannot find alternative safe placements for their funds in retirement"

I am assuming that in Leijonhufvud's view, even the savings account rate was low enough to be one reason for his concern that there existed a subsidy.

A low interest rate on a savings account deposit is not directly determined by the Fed. Banks would like to pay depositors less but competition between banks can force that rate higher. The reason competition does not force that rate higher is because in an economy that the Fed thinks requires stimulus, such as in 2011, households and businesses are more risk averse than usual so they allocate less to risky holdings and more to low risk holdings like deposits.

A side matter... If there is inadequate competition, that is a different subject. The Leijonhufvud article does not seem to be blaming a lack of competition.


---

### Answer by username_3 on 2022-02-21. Score: 1

To my best knowledge there is no research directly examining this question empirically for the United States banking sector, although it’s possible I might have missed something in which case I hope some other answer answers it.

As a consequence I don’t see any way how there could be significant consensus on the matter. Nonetheless, there is some indirect evidence.There is actually quite a lot of research on relationship between monetary policy and bank profitability.

For example, [Borio et al (2017)](https://onlinelibrary.wiley.com/doi/full/10.1111/infi.12104?casa_token=luC2reyU3R8AAAAA%3AlHyltyXsEQuRIr2A2PNN9G5XCOeG__gf4eMq6_z9WjEgcNMFmWpbLwDqdHiOp0QJtivwYV9Gw3ly2E0), [Altavilla (2018)](https://academic.oup.com/economicpolicy/article/33/96/531/5124289?login=true) or specifically for US [Goodhart, & Kabiri, (2019)](https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3395190) show that loose monetary policy reduces overall bank profitability. This in itself does not mean there is no implicit subsidy because maybe profitability falls despite implicit subsidy the banks get. However, this being said it’s not that common for business that get subsidized implicitly to experience lower profits, so at least you could consider this to be indirect evidence for it.

In addition, the mechanism mentioned in most of the papers for increase in profitability would be increase in demand for bank loans as opposed to some implicit subsidy by lowering the cost of funds.

Nonetheless, there is also some evidence from large panel of counties that shows that although bank profitability falls the spread between deposit and lending rates increases ([Zimmermann 2019](https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3322331)). Hence, this could be perhaps viewed as evidence for banks being *implicitly* subsidized since it would lower their costs of funds while their prices do not fall enough to keep their margins constant. One could argue that would be an implicit subsidy.

On other hand there are also some good papers that claim that low interest rates do not negatively affect bank profitability such as [Altavilla et al (2017)](https://www.ecb.europa.eu/pub/pdf/scpwps/ecb.wp2105.en.pdf). The argument goes that that once you better control for endogeneity and after some time (in a very short run the profits can still be negatively affected).

Also to be clear most of the evidence above is from either international set of countries or Europe. In principle there could be some heterogeneity.

As you can see above the evidence is mixed. Nonetheless, most studies find negative or no relationships. it is more rare to find positive relationships. Consequently, this can be interpreted as that either there aren’t implicit subsidies or if there are some they are too small to offset negative impact on profitability of low interest rates. Lastly to be clear if there are any subsidies they are implicit not explicit ones.


---

