Eliminating Interest on Excess Reserve Payments Could Boost Inflation Risk, Research Argues
The risk of inflation would dramatically rise if the Fed were unable to pay interest on excess reserves, which enables policy makers to put a floor under short-term interest rates, according to a new research paper commissioned by the American Bankers Association. Karen Shaw Petrou of Federal Financial Analytics writes that without paying interest on reserves or using overnight reverse repurchase agreements, the Fed wouldn’t be able to put a floor under rates, because other policy tools no longer function as they used to. Eliminating those tools would create a shadow monetary-policy transmission, forcing the Fed to rely on nonbanks and government-sponsored enterprises for its short-term floor, Ms. Petrou argues. The Fed could also try to sell assets, but that could be destabilizing and also cause it to lose a lot of money, she wrote.