IOER and money markets

Fed Looks for Other Ways to Aid Economy by Binyamin Appelbaum

The account said that most officials were open to the idea of encouraging bank lending by reducing the interest rate on funds that banks keep on deposit with the central bank. Those reserves have ballooned with the Fed’s bond purchases, because the Fed buys bonds from the banks and then credits their reserve accounts.

The Fed currently pays annual interest of 0.25 percent on bank reserves, which sounds like a pittance but cost $199 million in 2012. Officials have described the payments as a way of keeping inflation under control, because the reserves stay at the Fed. But with inflation sagging, economists including Princeton University’s Alan Blinder have argued that the Fed should revisit its priorities.

The account the Fed released on Wednesday said the idea “could be worth considering at some stage,” though it noted the benefits were likely to be small.

Janet L. Yellen, President Obama’s nominee to lead the Fed for the next four years, said at her confirmation hearing last week that the idea “certainly is a possibility.” She added, however, that officials remain concerned that a rate cut would disrupt financial markets. Keeping the interest rate on reserves above zero, for example, has created an incentive for banks to borrow from money market funds and then deposit the money with the Fed. In the absence of those payments, the money funds might actually be forced to pay the banks to take that same money.

“We’ve worried that if we were to lower that rate to close to zero, we would begin to impair money-market function,” Ms. Yellen said at the hearing.