Wednesday, July 21, 2010

The Fed & Interest on Reserves

Ending Interest on Reserves Won’t Help - Real Time Economics - WSJ
Financial markets are abuzz with chatter that in a bid to stimulate the economy, the Federal Reserve would suspend paying interest on the reserves banks have parked on its balance sheet.

Right now, banks hold some $1 trillion in reserves at the Fed. The reasons for doing that are many, but a key motivation is the 0.25% return they can collect. Not much, but something when the federal-funds rate is essentially at 0%.
Some economists have argued that the payment
of interest on reserves is in fact a tool of monetary policy and that the
payment of interests on reserves by the Fed is working at cross purposes to its
operations to add liquidity that started in late 2008.  Who knows,
perhaps when the history of this crisis is written the payment of
interest on reserves will be seen as a mistake because it reduced the velocity of money at a time when it seemed everyone (not you, Austrians) thought we needed to increase it (and everyone thought that is what they were doing).

The WSJ post that this comes from offers this as a reason against the possible move:
“If the Fed were to reduce the interest rate paid on excess reserves to
zero, the Day One story in the press would be ‘Fed Moves to Support
Economy,’” they wrote. “The Day Two story would be ‘Analysts Call Fed
Action Futile,’” and “that is exactly the kind of storyline Bernanke
should want to steer away from,” Wrightson strategists warned.
The Fed has a hard enough time carrying out its dual mandate of stable prices and full employment.  I really don't think we need to add "Pleasing Wall Street Analysts" to the list.  In fact, if there is one thing I fear more than the politicization of our nation's monetary policy, it is having it be in thrall to Wall St. We've already suffered through that once under Mr. Greenspan.

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