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Should the Fed pay interest on deposits?
Steve Randy Waldman says yes:
I would support a standalone act authorizing the Fed to pay interest on deposits immediately. I would prefer that Congress impose limits on the quantity of deposits on which interest can be paid, to limit the risk and interests cost to taxpayers, but that limit could be quite loose for the moment. This approach has the advantage of getting liquidity into the banking system far more quickly than the Paulson Plan ever could have, and drawing a clear line between the liquidity and capitalization aspects of the plan. It could be implemented immediately by passing the one sentence Section 128 of the Paulson Plan in isolation (although again, I'd prefer to muck it up with a limit on the quantity of paid deposits).
Freed of its balance sheet constraint, the Fed might consider injecting funds into the banking system by purchasing a diversified portfolio of holdings in money market funds that trade in commercial rather than government paper. This would help relieve the stresses in the commercial paper market very directly, and reduce the likelihood of a disorderly adjustment in nonfinancial commercial credit markets.
On a different tack, here are some very good ideas from Paul Light, an expert on bureaucracy. And did you know that the FDIC currently has the power to guarantee short-term interbank lending? The Paulson plan was in fact quite slow, so maybe its failure will force us to look for other and better options.
Posted by Tyler Cowen on September 30, 2008 at 08:29 AM in Economics | Permalink
Comments
"And did you know that the FDIC currently has the power to guarantee short-term interbank lending? The Paulson plan was in fact quite slow, so maybe its failure will force us to look for other and better options."
No, I didn't know that. But then I'm not the head of the Federal Reserve, Treasury, or FDIC.
So here's what I don't understand. If the credit freeze is due to banks being afraid to lend to each other [and aren't they supposed to be lending to people and other businesses, not each other so much?], why didn't we do this? There are probably good reasons; just wondering what they are.
Posted by: ZBicyclist at Sep 30, 2008 9:49:35 AM
Didn't the Fed ask Congress for permission to pay interest on commercial bank reserves earlier this year?
http://online.wsj.com/article/SB121011673771072231.html
Posted by: Matt S. at Sep 30, 2008 11:04:48 AM
An article on bureaucracy and government that starts with...
"With Congress out of session for Rosh Hashanah"
That just gave me a Dilbert moment. What a bunch of clowns. Thank you. I needed that since PhD Comics stopped providing new ones.
Posted by: Andrew at Sep 30, 2008 11:35:17 AM
Bizarre. Non-borrowed Reserves at the Fed are negative , i.e. the quantity of zero interest deposits are actually less than zero. The Fed currently has hundreds of billions swaps where they are lending out funds at 2% and accepting collateral of MBS which are paying, I don't know, 7% or 8%. In other words, they are lending out funds at 2% to finance the purchase of assets that pay 600 basis points more and then holding all of the risk on their own balance sheets and giving all of the profits to the counter-parties.
And somehow the problem is that the Fed doesn't pay interest on deposits.
Posted by: AldenP at Sep 30, 2008 2:34:11 PM
The Bank of Canada pays interest on deposits, and has done so for many years. The interest rate is always set 25 basis points below the target for the overnight rate.
As far as I can see, allowing the Fed to pay interest on deposits is very similar to allowing the Fed to issue its own T-bills. Interest paying deposits at the Fed and T-bills are both very liquid and very safe short term loans, so should be close substitutes. The Fed could then conduct an open market purchase of long bonds (or commercial paper, or....), and the cash would return as deposits to the Fed, and so would be automatically sterilised. This is functionally equivalent to the Fed buying long bonds (or commercial paper, or...) and paying for them with T-bills. Which in turn is close to being functionally equivalent to the Paulson plan. So, with interest on deposits, the Fed can replace the Treasury.
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