Wednesday, January 16, 2013

Interest Pay on Reserves as Monetary Policy Tool

The idea of a platinum coin has been ruled out (example of news here), but the thought exercise on what might follow if it were to happened brings up some interesting discussions on possible monetary policy going forward.

Tim Duy gave his thoughts here, quoting from posts of Paul Krugman and Steve Randy Waldman.

I do think interest pay on reserves would be an important tool when the Federal Reserve decides to unwind QE and lowers its reserve balance – particularly if the Federal Reserve decides to unwind slowly. But the following point about interest on reserves is particularly interesting (and I have not though of):

As Krugman correctly notes, in this world the Treasury, not the Fed, is effectively paying the interest on reserves.  Thus, we really shouldn't consider the excess reserves as monetary base (with the connotation that these reserves are simply cash ready to be lent out), but as psuedo-government debt (and I thank Gavyn Davies for pointing this out to me, so I hope I got his meaning correct).