Alan Blinder: make banks pay interest on excess reserves held at the Federal Reserve

In the history of advanced capitalism, the US measure of ‘money velocity‘ is at an all-time low.

So while I apologize that I’m just coming to this now, better late than never: here’s Alan Blinder, back in July, in the WSJ, suggesting the Fed stop paying interest on excess reserves, and indeed, start charging a fee for banks to park money at the Fed rather than put it into velocity.

I have two out-of-the-box suggestions to make, one in today’s column and another in a companion piece soon.

The simpler option is one I’ve been urging on the Fed for more than two years: Lower the interest rate paid on excess reserves. The basic idea is simple. If the Fed reduces the reward for holding excess reserves, banks will hold less of them—which means they will have to find something else to do with the money, such as lending it out or putting it in the capital markets.

The Fed sees this as a radical change. But remember that it paid no interest on reserves before the 2008 crisis and, not surprisingly, banks held practically no excess reserves then. In early October of that year, Congress gave the Fed authority to pay interest on reserves, which it promptly started doing. When the Fed trimmed the federal funds rate to its current 0-25 basis-point range in December 2008, it also lowered the interest rate on reserves to 25 basis points, where it has been ever since.

My suggestion is to push it lower in two stages. First, test the waters by cutting the interest on excess reserves (in Fedspeak, the “IOER”) to zero. Then, if nothing goes wrong, drop it to, say, minus-25 basis points—that is, charge banks a fee for holding their money at the Fed. Doing so would provide a powerful incentive for banks to disgorge some of their idle reserves. True, most of the money would probably find its way into short-term money-market instruments such as fed funds, T-bills and commercial paper. But some would probably flow into increased lending, which is just what the economy needs.

Advertisements
This entry was posted in economic recovery, macro-economics, money and finance, money velocity, qualitative sociology of economics and politics, sociology. Bookmark the permalink.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s