Floored!: How a Misguided Fed Experiment Deepened and Prolonged the Great Recession

by George Selgin

In October 2008, as the U.S. economy plunged, the Federal Reserve began paying interest on banks' reserve balances. The resulting switch to a "floor system" of monetary control, in which changes in the interest rate on reserves, rather than reserve creation or destruction, became the Fed's chief tool for influencing economic activity, was to have far-reaching consequences--almost all of them regrettable. Besides intensifying the downturn by causing banks to hoard reserves, the floor system all but destroyed the market for unsecured interbank loans that had been banks' ordinary "first resort" source of last-minute liquidity. By depriving the Fed's asset purchases of the ability to stimulate investment and spending, it also compelled the Fed to compensate by purchasing assets on an unprecedented scale. All of this resulted in a substantial increase in the Fed's role in allocating scarce credit. Finally, by severing the ordinary connection between the stance of monetary policy and the extent of the Fed's asset holdings, the floor system risks turning the Fed's balance sheet into a fiscal-policy playground. Floored! offers a matchless account of our post-crisis monetary system's history and shortcomings.

Genres: Finance, Economics, Business, History, Nonfiction

230 pages, Paperback

Published October 22, 2018

Reviews

[Frank Stein · Rating 4 out of 5]

Selgin makes a comprehensive and convincing case against the Federal Reserve's post-2008 floor system. He explains first that it is illegal under the 2006 law authorizing the Fed to pay interest on reserves, which said such interest had to be lower than short-term funding rates (by definition the floor system has to keep interest on reserves over such rates.) It has inhibited lending and monetary policy during a period of excessive tightness of the Federal Reserve, which Bernanke even admitted in 2008, but which somehow was ignored after the Fed tried to expand lending in 2009 and onwards. It also shows that simple data shows that reserves displaced lending on many bank balance sheets and led to credit rationing and financial repression that the Fed should avoid.

The book is less convincing that the 25 basis point floor system from 2008 to 2015 had a large and substantial impact on lending, based on studies that showed that even at 6 basis points lending margin banks would still lend, but it does show that at the least it inhibited some loans. It also showed the fiscal dangers a large balance sheet denoted for the Fed, which would mean it would suffer losses on assets and stop sending money to the Treasury. In an inflationary world, one where the Fed is losing money every month, this last piece is the one that today will rightfully attract the most attention.

[Fidel Morla · Rating 5 out of 5]

As an economist working in the Reserve Management Subdirectorate of a central bank, I picked up Floored! with professional curiosity—and ended up being completely engrossed. Selgin has done something rare here: he’s taken a highly technical and often misunderstood aspect of modern central banking—the post-2008 shift to a floor system for interest rates—and made it not only accessible, but deeply thought-provoking.

George’s central argument, that the Fed’s adoption of a floor system inadvertently prolonged the Great Recession by stifling interbank activity and weakening monetary transmission, is laid out with impressive clarity and rigor. What I appreciated most is how he weaves institutional detail with economic logic, showing how a well-intentioned policy innovation can yield unintended consequences when detached from market discipline and historical context.

This book has changed the way I think about excess reserves, interest on reserves, and the broader role of central bank balance sheets in shaping macroeconomic outcomes. It’s not just theory—Selgin’s insights resonate with the practical challenges we face managing reserves and liquidity in today's financial environment.

Whether you're inside a central bank or just passionate about monetary policy, Floored! is essential reading. It’s smart, engaging, and—most importantly—it challenges orthodoxy in a way that invites real debate. I’ll definitely be recommending it to colleagues.