Bank Lending in Times of Large Bank Reserves

Reserves held by the U.S. banking system rose from under $50 billion before 2008 to $2.8 trillion by 2014. Some economists argue that such a large quantity of reserves could lead to overly expansive bank lending as the economy recovers, regardless of the Federal Reserve’s interest rate policy. In contrast, we show that the amount of bank reserves has no effect on bank lending in a frictionless model of the current banking system, in which interest is paid on reserves and there are no binding reserve requirements. Moreover, we find that with balance sheet costs, large reserve balances may instead be contractionary.