Fed To Pay Interest on Required and Excess Reserves
The Federal Reserve Board announced that it will begin to pay interest on depository institutions’ required and excess reserve balances. The payment of interest on excess reserve balances will give the Federal Reserve greater scope to use its lending programs to address conditions in credit markets while also maintaining the federal funds rate close to the target established by the Federal Open Market Committee.
FAQs about Interest on Reserves and the Implementation of Monetary Policy
October 6th, 2008 at 11:46 am
does anybody smell a desire for deposits here from foreign central banks. This smells like a warning sign.
October 6th, 2008 at 12:23 pm
Nick:
no relation, this has always been standard practice for “modern” central banks like ECB, and makes it easier for them to do their job. The Fed was just behind the times, catching up slowly.
October 7th, 2008 at 7:36 pm
My thoughts: Payment of interest on “excess reserves” is method by which the “trading desk” can raise commercial bank reserve requirements. The larger the volume of a bank’s discretionary, or liquidity reserves, where risk-free interest payments are applied (excess reserves, & excess contractual clearing balances), the lower the banking system’s expansion coefficient.
Also, the payment of interest on these unused balances will drive the FFR lower, as one rate is risk-free & the other inter-bank rate’s risk is unknown. Presumably, a reduction in the volume of inter-bank lending may be displaced because of disproportionately larger volume of excess-balances (and potentially redistributed, excess vault cash).
I see no problem whatsoever with the FFR crashing to zero or negative rates or whatever. Legal reserves are independent of the FFR. The money supply can never be managed by any attempt to control the cost of credit. Let the markets decide money market interest rates.
The lending capacity of the banking system is dependent upon the volume of legal reserves. Free/gratis legal reserves, as contrasted to liquidity or prudential reserves, are a necessary requirement of all money creating institutions, with the exception of Central Banks.
Barring the necessary legal restraints, these institutions will create an excessive volume of money. Barring direct authoritarian controls, the only method by which the volume of money can be properly regulated is through Central Bank control of commercial bank free/gratis legal reserves and reserve ratios (the minimal ratios of legal reserve assets held by the commercial banks to their deposit liabilities).
To be effective, the free/gratis legal reserves of commercial banks must be confined to a bank asset that can be constantly monitored and controlled by the monetary authorities. Only Federal Reserve Bank inter-bank demand deposits (FRBIBDD) meet this condition. The volume of FRBIBDDs is almost exclusively related to the volume of Reserve Bank credit. That is Reserve Banks acquire Treasury Bills, etc., by creating IBDDs – the free/gratis legal reserves of money creating institutions.
October 8th, 2008 at 6:18 pm
Anyone ever monitor settlement or bank clearings within their district Federal Reserve Bank? These payment figures are extremely volatile, but the FED intends to base it’s monetary policy on clearings.
Anyone ever see a study showing the relationship between the level and duration of interest rates as they relate to legal reserves or commercial bank credit? Little surprise that Greenspan kept rates too low for too long.