Excess reserves are nearly $1.4 trillion and yet the Fed needed to inject $53 billion to bring overnight repo rates down from a high of 10%. The assumption is that we do not have enough excess reserves. It’s not that there aren’t enough reserves, but that they are difficult to pry loose from the Fed when they are paying 2.10% with essentially zero risk of default.
Simply look at how the actual fed funds rate being charged between banks overnight is never lower than the interest paid by the Fed. Today the rate reached the upper bound of the Fed’s target rate of 2.25%.
The Fed needs to stop paying interest on all of the excess reserves and require banks to post T-Bills for a portion of their excess reserves. This would immediately reduce T-Bill yields, steepen the yield curve, and most importantly free up excess reserves for overnight liquidity needs. As it stands now, it will always look like there is never enough excess reserves because every dollar the Fed prints to increase its balance sheet will get sucked right back to being deposited at the Fed to earn 2.1%. Especially in times of uncertainty. So when the market needs liquidity the most will be precisely when excess reserves will be the most difficult to pull away from the Fed to be lent to other banks.