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The Politics of Paying Interest on Bank Reserves

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  • Thomas Palley

Abstract

The Federal Reserve has recently activated its newly acquired powers to pay interest on reserves of depository institutions. The Fed maintains that its new policy increases economic efficiency and intends it to play a lead role in the exit from quantitative easing. This paper argues it is a bad policy that has a deflationary bias; is costly to taxpayers, and that cost will increase as normal conditions return; and establishes institutional lock-in that obstructs desirable changes to regulatory policy. The paper recommends repealing the Fed's power to pay interest on bank reserves. Second, the Fed should repeal regulation Q, which prohibits payment of interest on demand deposits. Third, the Fed should immediately implement an alternative system of asset-based reserve requirements (liquidity ratios) that will improve monetary control and can help exit quantitative easing at no cost to the public purse. Now is the optimal time for this change.

Suggested Citation

  • Thomas Palley, 2010. "The Politics of Paying Interest on Bank Reserves," Challenge, Taylor & Francis Journals, vol. 53(3), pages 49-65.
    • Handle: RePEc:mes:challe:v:53:y:2010:i:3:p:49-65
    DOI: 10.2753/0577-5132530303
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    References listed on IDEAS

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    1. Olivier Blanchard & Giovanni Dell’Ariccia & Paolo Mauro, 2010. "Rethinking Macroeconomic Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(s1), pages 199-215, September.
    2. Thomas Mayer, 1966. "Interest Payments On Required Reserve Balances," Journal of Finance, American Finance Association, vol. 21(1), pages 116-118, March.
    3. Thomas Palley, 2003. "Asset Price Bubbles and the Case for Asset-Based Reserve Requirements," Challenge, Taylor & Francis Journals, vol. 46(3), pages 53-72.
    4. Todd Keister & Antoine Martin & James J. McAndrews, 2008. "Divorcing money from monetary policy," Economic Policy Review, Federal Reserve Bank of New York, vol. 14(Sep), pages 41-56.
    5. Olivier Blanchard & Giovanni Dell'Ariccia & Paolo Mauro, 2010. "Rethinking Macroeconomic Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(s1), pages 199-215, September.
    6. Thomas Palley, 2004. "Asset-based reserve requirements: reasserting domestic monetary control in an era of financial innovation and instability," Review of Political Economy, Taylor & Francis Journals, vol. 16(1), pages 43-58.
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    Cited by:

    1. Brett Fiebiger, 2016. "Fiscal Policy, Monetary Policy and the Mechanics of Modern Clearing and Settlement Systems," Review of Political Economy, Taylor & Francis Journals, vol. 28(4), pages 590-608, October.

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