Banks’ excess reserves, or deposits held with the Fed above required amounts, totaled $1 trillion in the two weeks ended Jan. 13, compared with $2.2 billion at the start of 2007. The Fed created the reserves through emergency loans and a $1.7 trillion purchase program of mortgage-backed securities, federal agency and Treasury debt.
By raising the deposit rate, now at 0.25 percent, officials reckon banks will keep money at the Fed and not stoke inflation by lending out too much as the economy recovers.
People have wondered for a while what’s the Fed’s “exit strategy” from the current bout of credit easing, and there you have it. Raising the interest rate on excess reserves from 0.25 percent to 0.5 percent or .75 percent or 1 percent would have a contractionary impact and help curb inflation if this becomes a problem in the future. Today, however, inflation is not a problem. Very high unemployment, however, is a problem. So if raising the rate from 0.25 to .5 produces contraction, then why shouldn’t lowering it from 0.25 percent to 0 percent percent produce expansion? What’s more, there’s no “zero bound” on this rate—the Fed could charge a .25 percent penalty on excess reserves if it wanted to. Of course there’s a zero bound on the actual quantity of excess reserves themselves. But right now there’s $1 trillion in excess reserves. Charge a penalty, and banks will have an incentive to put that $1 trillion into the economy.
Of course additional fiscal measures would also be welcome, but the suicidal Senate apparently wants to limit the cost to $80 billion which isn’t going to have much impact.
This, to my mind, is the sort of Bernanke-related issue we should be talking about. “Should the Fed lower the interest rate on excess reserves” sounds boring as hell, but it’s literally a trillion dollar question. Complaining about past bailouts is more fun, but what does it accomplish?