- change ups
What will increase spending?
By creating almost $2 trillion in bank reserves, the Fed has created the potential for a massive increase in spending.
Path to spending
For the increase in spending to occur, the reserves must go through the banking system and be transformed into new money.
Through the first half of this year, there are no signs of significant growth in either bank loans and investments or bank deposits. Growth has been only 1.8 percent at an annual rate in the first half of this year.
Newly created reserves have not been turned into money, because Dodd-Frank regulations and aggressive regulators have imposed significant burdens on banks.
Over the past few years, the impact of these burdens has completely offset the potential impact of the increase in reserves, leading to only a sluggish 3.5 percent increase in current dollar spending.
The pressures on the banking system are temporary.
As housing prices and business activity improve, regulators will upgrade bank loans and recognize a higher level of bank capital.
Once bank regulators are satisfied with the level of bank capital, banks will begin to use their massive increase in bank reserves to boost loans and investments.
Once that happens, the pace of spending will accelerate and interest rates will move sharply higher.