Reference no: EM131930682

It’s a recent invention of the Fed to pay interest to banks on reserve deposits held there. The current interest rate is an annual rate of 1.25%, and it applies to both required reserves and excess reserves.

There’s something about this innovation that strikes me as being rather odd. The interest innovation was introduced during a time when the Fed was concentrating intensely on a program of Quantitative Easing. One might expect the introduction of interest payments to be part of a tightening policy rather than an easing policy: If banks are suddenly able to earn money by holding excess reserves, we might expect that to discourage lending rather than encourage it, resulting in less easing in credit markets. If banks are now able to earn a return without incurring risks and without administrative expenses, would we not expect that to reduce their motivation to lend money into the private economy?

Hence, this (last) question of the week: What argument(s) do you believe might be reasonably made in support of the view that Fed interest payments on bank reserves might not conflict with the goals of a program of monetary easing?