From a policy standpoint, another interesting statement by Bernanke came during the Q&As that followed his speech when Bernanke indicated that reducing the rate of interest paid on reserves by the Fed would have little stimulative effect on bank lending. (For more details, see Joe Weisenthal of Business Insider)
This is actually significant seeing as Bernanke suggested in the past that one of the options that the Fed has to entice banks to lend is to reduce the rate of interest paid on reserves. Here is an excerpt from his testimony before Congress in July of last year:
...we have a number of ways in which we could act to ease financial conditions further. [...] The Federal Reserve could also reduce the 25 basis point rate of interest it pays to banks on their reserves, thereby putting downward pressure on short-term rates more generally.Recall that since December 2008 when the Fed started paying interest on reserves, the Fed's instrument has been effectively its asset portfolio. The policy of paying interest on reserves is a policy tool used to support the active use of this instrument.
So why the change of heart? Is there any evidence that in the scope of it all that 25 bps would indeed make a significant difference?
ReplyDelete-2plates
Thanks for your question, 2plates. Apologies for the delay. Indeed, there is no evidence in the US context that reducing the rate paid on reserves would spur lending. I think Bernanke has been convinced by some of the analyses on this topic of late within the FRS, especially at the NY Fed (see reference below).
ReplyDeleteThe belief that reducing is rate paid on reserves would create the incentive for banks to lend out some of the excess reserves held at the Fed is the result of an illusion. Briefly, to explain, the size of the US monetary is due to the Fed's asset purchases (asset side of the Fed's balance sheet). Accordingly, the proposal to reduce the rate paid on reserves would have no impact on the size of the monetary base unless it is combined by a simultaneous sell-off of the Fed's assets (since the base reflects the other side of the Fed's balance sheet).
As for the argument that a reduction (or elimination) of the rate paid on reserves could spark changes affecting other interest rates, this too is not wholly convincing. Antinolfi and Keister addressed this issue in a recent article on the NY Fed blog entitled "Interest on Excess Reserves and Cash “Parked” at the Fed":
"This logic doesn’t imply that changing the IOER rate would have no effect on banks’ lending decisions, of course. A change in this rate could feed through to changes in other interest rates in the economy and thereby potentially affect the incentives for banks to lend and for firms and households to borrow. Lowering this rate may also lead to disruptions in markets that weren’t designed to operate at very low interest rates (see this earlier post for a discussion). Households and firms could respond to these changes in ways that either increase or decrease the amount of currency in circulation, the level of bank deposits, required reserves, and other variables. These shifts would likely be small, however, and should not obscure the basic point: The quantity of balances banks hold on deposit at the Fed would be essentially unaffected by a change in the IOER rate."