Bernanke Wants Fed to Pay Interest on Bank Reserves
Federal Reserve Chairman Ben S. Bernanke, seeking ways to stabilize money markets, will ask Congress for authority to pay interest on commercial-bank reserves this year, a person familiar with the discussions said.
The central bank isn't authorized by Congress to begin making such payments until 2011. Allowing interest on bank reserves may allow the Fed to pump more funds into the banking system without pushing its main policy rate lower, in effect separating action to boost liquidity from monetary policy.
“It would have the effect of putting a floor under the federal funds rate,'' said Walker Todd, a research fellow at the American Institute for Economic Research in Great Barrington, Massachusetts.
Bernanke has expanded the Fed's tools during the credit crisis, rolling out three new facilities aimed at getting funds to the financial system more effectively. The Fed's Board of Governors discussed paying interest on reserves in a closed session on April 30, according to public records. The Federal Open Market Committee, which includes governors and presidents of the 12 district banks, cut its benchmark federal funds rate to 2 percent the same day.
Banks are required to hold a proportion of customers' deposits in an account at the Federal Reserve. In addition, they hold reserves in excess of their required balances to meet payments.
Fed staff initiated discussions this week with Congress about bringing forward the date that interest can be paid on the reserves, the person said. Technical details of how the program would work, and what rate the Fed would pay, would likely need further study and discussion by the FOMC, the person said.
Excess Cash
If the Fed paid an interest rate equal to the federal funds rate, commercial banks would avoid dumping any excess cash into money market, which in the past has driven rates below the Fed's target.
The New York Fed bank's Open Market Desk is charged with buying and selling Treasuries with 20 Wall Street securities firms to keep the rate close to the target set by the FOMC.
The desk has struggled to keep the federal funds rate stable as banks attempted to manage their reserve needs most effectively at a time when credit markets were seizing up.
The federal funds rate on May 2 traded in a range of 0.1 percent to 2.5 percent even though the target was 2 percent. On April 23, the rate traded as low as 1 percent and as high as 10 percent, even though the target rate was 2.25 percent.
Inter-Bank Rate
“The inter-bank interest rate is going to be stabilized with this policy,'' said Marvin Goodfriend, a professor at Carnegie Mellon University's Tepper Graduate School of Business and a former Richmond Fed policy adviser who has published research on interest on reserves.
Under the current statute, the Fed may pay interest “at a rate or rates not to exceed the general level of short-term interest rates'' starting in October 2011.
On May 2, the Fed expanded a facility where it swaps Treasury securities for mortgage bonds to include asset-backed bonds, including those backed by student loans. The expansion of the so-called term securities lending facility came after two separate requests from Congress to do so. While the Fed aims to add liquidity to these specific asset classes, the swaps can also impact pricing of these securities.
If the Fed wanted to expand such policies and, for example, buy billions of dollars in municipal bonds without depressing the federal funds rate, paying interest on reserves could attract the excess cash held by banks and “suck it back in'' to balances held at the Fed, Todd said.
The central bank's request to Congress was previously reported by the Wall Street Journal today.
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