Dollars and Jens
Monday, October 06, 2008
Fed to pay interest on bank reserves
I had suggested some time ago that the Fed pay interest on excess bank reserves as a way to set a floor on the fed funds rate, not realizing until a week or two ago that they actually didn't have the statutory authority to do so. They acquired that statutory authority when the President signed that bill last Friday, and announced today that they will be paying 125bp on excess reserves and 190bp on required reserves.

I had not included, in my plan, paying interest on required reserves, mostly because of the fiscal impact, and because it shouldn't have an effect on bank behavior — they should have the same quantity of required reserves regardless of interest received thereon because they're, you know, required. It seems a little odd to me to be paying substantially more than they do on excess reserves. Anyway, the overnight fed funds rate over the last two weeks, except for last Friday for which I don't have a data point yet, was 1.32%, with a significant variance; it may well start to show up at 1.25 consistently this week. Unless, of course, the rates get cut, which they could well do.

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