By Brai Odion-Esene

WASHINGTON (MNI) – If the Federal Reserve decided to reduce the
interest it pays on excess bank reserves held at the central bank, it
would not have a “meaningful” impact in lowering the quantity of
balances banks hold on deposit, Fed economists argued Monday.

In a posting on the New York Fed’s Liberty Street economics blog,
Gaetano Antinolfi, a senior economist at the Fed Board in Washington,
and Todd Keister, assistant vice president in the New York Fed’s
Research and Statistics Group, argued that because lowering the interest
rate paid on reserves wouldn’t change the quantity of assets held by the
Fed, it must not change the total size of the monetary base either.

A reluctance to cut the interest rate on excess reserves as a means
of easing monetary policy is one that has already been made public by
Fed policymakers, with the minutes of the Federal Open Market
Committee’s August meeting showing that just “a couple” of participants
supported such a reduction, with several others raising concerns about
the possible effects on money markets.

“Lowering this interest rate to zero (or even slightly below zero)
is unlikely to induce banks, firms, or households to start holding large
quantities of currency,” Antinolfi and Keister wrote. “It follows,
therefore, that lowering the interest rate paid on excess reserves will
not have any meaningful effect on the quantity of balances banks hold on
deposit at the Fed.”

They also argued that if the IOER rate were set sufficiently far
below zero, banks may choose to store currency rather than hold deposits
at the Fed, and households may prefer holding cash if banks impose
significant fees on deposits.

“In this case, the level of reserve balances would decline, but the
change would simply reflect a shift in the composition of the monetary
base; its total size would remain unchanged for the reasons described
above,” they said.

The Fed economists noted that decisions on idle cash and how much
of it they park at the Fed are usually made on an individual bank level,
mostly based on available lending opportunities and other factors.

“However, the logic above demonstrates that the total quantity of
reserve balances doesn’t depend on these individual decisions,” the Fed
economists added.

As for how what is true for each individual bank does not apply to
the banking system as a whole, Antinolfi and Keister said when one bank
decides to hold a lower balance in its reserve account, the funds it
sheds necessarily end up in the account of another bank, leaving the
total unchanged.

“In the aggregate, therefore, these balances do not represent
‘idle’ funds that the banking system is unwilling to lend,” they said.
“In fact, the total quantity of reserve balances held by banks conveys
no information about their lending activities — it simply reflects the
Federal Reserve’s decisions on how many assets to acquire.”

They caution that their argument does not mean changing the IOER
rate would have no effect on banks’ lending decisions. A change 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, they said.

And echoing the concerns of some on the FOMC, the Fed economists
said “lowering this rate may also lead to disruptions in markets that
weren’t designed to operate at very low interest rates … . 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,” Antinolfi and Keister said.

** MNI Washington Bureau: 202-371-2121 **

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