Fed Again Raises Rate Paid on Banks' Reserve Balances
The Federal Reserve boosted the interest rate it pays banks for the excess cash they keep on deposit, aiming to prevent its record injection of funds into the financial system from affecting its monetary policy.
“The rate on excess balances will be set equal to the lowest Federal Open Market Committee target rate in effect during the reserve maintenance period,'' the Fed said in a statement. The federal funds target stands at 1 percent.
The central bank will also pay interest on required reserves at the average federal funds rate. Fed officials are trying to fine-tune their interest-on-reserves rate as their liquidity facilities continue to over-supply the banking system with cash. Today's announcement marks the second adjustment in two weeks.
“This should keep all those excess reserves from pushing the effective federal funds rate down as low as it has been,'' said Brian Sack, vice president at Macroeconomic Advisers LLC in Washington and a former Fed Board economist. “The committee would like the federal funds rate to be closer to the target.''
The Fed's liquidity facilities make it difficult for central bankers to estimate how much cash they are oversupplying low fee pay day loans. For the two weeks ending Oct. 22, excess reserves averaged $282 billion, up from $136 billion in the prior two-week period ending Oct. 8.
The effective federal funds rate averaged 0.27 percentage point since policy makers cut the benchmark lending rate Oct. 29 to 1 percent. The Fed's previous target rate on excess reserve balances was 0.35 percentage point below the federal funds target.
The Fed started paying interest on reserves last month after gaining authority under the $700 billion financial-rescue bill passed by Congress.
“We're not quite sure what we have to pay in order to get the market rate, which includes some credit risk, up to the target,'' Chairman Ben S. Bernanke told economists Oct. 7. “We're going to experiment with this and try to find what the right spread is.''
Filed under: term by Finance Boss