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May 07, 2008
Fed wants authorization to pay interest on reserves
Reuters carried the story a few days ago and somehow I missed it.
WASHINGTON (Reuters) - The Federal Reserve's Board of Governors will hold a closed meeting on Wednesday [Apr. 30] to discuss paying interest on bank reserves, one of a number of options officials have been mulling to address liquidity problems in financial markets in case measures taken to date fail to gain traction.
This is not a sudden development, as the article goes on to point out...
Congress in 2006 granted the Fed authority beginning in 2011 to pay interest on bank reserves. At the time, the central bank assigned staff to study the implications such a move could have on its operations.
The staff report is now ready and will be presented to the Fed during the regularly scheduled meeting of its interest-rate setting panel, a Fed official added, declining to comment further on whether the presentation is pegged to any imminent steps to boost liquidity.
This was scheduled to go into effect in 2011, but they are looking for approval to start doing it now. I think that's a good idea. It is certainly not without precedent. Other central banks do it, including our neighbor to the north.
Now, the fact that this was passed back in 2006 went largely unnoticed, but not here. In fact, I even gave you a scholarly reference...
The October minutes are on the Fed's web site. Here's the first thing that caught my eye.
The Chairman noted that the President had recently signed the Financial Services Regulatory Relief Act of 2006, which among its provisions gave the Federal Reserve discretion, beginning October 2011, both to pay interest on reserve balances and to reduce further or eliminate reserve requirements. The Act potentially has important implications for many aspects of the Federal Reserve's operations and the Chairman asked Vincent Reinhart, Director of the Division of Monetary Affairs, to form a committee of Federal Reserve System staff to consider these issues.
They could learn from Canada, the UK, and New Zealand, as this publication by Sellon and Weiner from the Kansas City Fed explains.
And here's a technical paper on how the Bank of Canada does it.
I'll go on the record that this is a good idea. It will help to smooth out the recent fluctuations in the funds rate that garnered so much consternation at this blog among other places. It would prevent interest rate policy from getting in the way of policies for directly injecting liquidity into the financial markets by effectively keeping a floor on the funds rate even during a big injection of liquidity.
Fed Governor Donald Kohn spoke about it back in 2004 as well.
Hat tip to Barry Ritholtz and the WSJ.
UPDATE: Mark Thoma thought of it too.
Posted by William Polley at May 7, 2008 12:25 AM
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Comments
You're insane. You are saying that just because other tinpot countries do it, that makes it ok that the US Fed should do it too? As for smoothing out fluctuations in the funds rate, your base message seems to be that you approve of the idiotic wholesale bailout by the Fed of the morons that created this mess of INSOLVENCY in the USA. Laughable.
Posted by: Sceptical at May 7, 2008 03:47 AM
Thanks for putting this together. I hope congress will approve the Fed paying interest on all reserves, not just the amount over the reserve minimum. Congress shouldn't be worrying about $120M cost difference to the Treasury - the financial efficiency gained is a net gain to us all.
Posted by: AK MA at May 7, 2008 12:14 PM