Friday, August 27, 2010
In his speech today at the annual Fed conference in Jackson Hole, Wyoming, Ben Bernanke laid out the options for further stimulus from the Fed. He dismissed the possibility of lowering the interest on excess reserves rate (IOER, what the Europeans call the Lombard rate), the interest rate the Fed pays to banks on money they keep in their deposit accounts at the Fed. Excess reserves (above those required to back checking deposits) are normally almost nothing, but since the crisis began have hovered close to 2 trillion dollars. The IOER is currently 25 basis points (0.25%), while the Fed funds rate hangs around 10 to 15 basis points, and the primary discount rate is at 75 basis points. The chairman argues that cutting IOER to zero would not affect the Fed funds rate, and so is useless. He's probably right about that, but the point of doing it would be to make holding excess reserves less attractive, inducing banks to make loans instead. Bernanke also says that pushing IOER to zero "could disrupt some key financial markets and institutions." I'm much more convinced by the argument of Alan Blinder in a recent WSJ op-ed (is he running for something?). Paying a non-zero IOER at this point just gives banks a way to make money without sacrificing liquidity or making loans, and so keeps credit stopped up, especially to small businesses and consumers. The Fed did not even have the authority to pay IOER until three years ago, so it's not clear why going back to a zero rate would disrupt market institutions. It's certainly not having its expected effect of setting a floor under the Fed funds rate. This seems to me to be one of the few potentially effective tools the Fed has left in its toolbox. Now is the time to get it out and use it.