The Reserve Supply Channel of Unconventional Monetary Policy

We document the "reserve supply channel" of Quantitative Easing (QE) that has the unintended consequence of reducing bank lending to firms. Each dollar of central bank reserves created by QE crowds out 13 cents of bank lending. We reach this conclusion using a structural model that is estimated with instrumental variables for deposit and loan demand across regions of the country. Our results depend on two key estimates: the elasticity of demand for bank loans and how the cost of supplying loans is impacted by a bank's holding of reserves. We find that each $1 trillion of reserves in the banking system raises the cost of capital for loans by 1.5 basis points, leading to a 3.42% reduction in the quantity of corporate loans demanded. In a counterfactual simulation, we show that the $2.7 trillion of reserves created by QE reduced bank lending to firms by over $500 billion but had modest impacts on deposit and mortgage quantities. Our results imply that forcing the banking sector to hold the large quantity of reserves created by QE reduces QE's ability to stimulate the economy. This unintended consequence of QE could potentially be alleviated by the relaxation of the Supplementary Leverage Ratio (SLR) regulation.