Should the Fed pay interest on deposits?

Steve Randy Waldman says yes:

I would support a standalone act authorizing the Fed to pay interest
on deposits immediately. I would prefer that Congress impose limits on
the quantity of deposits on which interest can be paid, to limit the
risk and interests cost to taxpayers, but that limit could be quite
loose for the moment. This approach has the advantage of getting
liquidity into the banking system far more quickly than the Paulson
Plan ever could have, and drawing a clear line between the liquidity
and capitalization aspects of the plan. It could be implemented
immediately by passing the one sentence Section 128 of the Paulson Plan
in isolation (although again, I’d prefer to muck it up with a limit on
the quantity of paid deposits).

Freed of its balance sheet constraint, the Fed might consider
injecting funds into the banking system by purchasing a diversified
portfolio of holdings in money market funds that trade in commercial
rather than government paper. This would help relieve the stresses in
the commercial paper market very directly, and reduce the likelihood of
a disorderly adjustment in nonfinancial commercial credit markets.

On a different tack, here are some very good ideas from Paul Light, an expert on bureaucracy.  And did you know that the FDIC currently has the power to guarantee short-term interbank lending?  The Paulson plan was in fact quite slow, so maybe its failure will force us to look for other and better options.

Comments

"And did you know that the FDIC currently has the power to guarantee short-term interbank lending? The Paulson plan was in fact quite slow, so maybe its failure will force us to look for other and better options."

No, I didn't know that. But then I'm not the head of the Federal Reserve, Treasury, or FDIC.

So here's what I don't understand. If the credit freeze is due to banks being afraid to lend to each other [and aren't they supposed to be lending to people and other businesses, not each other so much?], why didn't we do this? There are probably good reasons; just wondering what they are.

An article on bureaucracy and government that starts with...

"With Congress out of session for Rosh Hashanah"

That just gave me a Dilbert moment. What a bunch of clowns. Thank you. I needed that since PhD Comics stopped providing new ones.

The Bank of Canada pays interest on deposits, and has done so for many years. The interest rate is always set 25 basis points below the target for the overnight rate.

As far as I can see, allowing the Fed to pay interest on deposits is very similar to allowing the Fed to issue its own T-bills. Interest paying deposits at the Fed and T-bills are both very liquid and very safe short term loans, so should be close substitutes. The Fed could then conduct an open market purchase of long bonds (or commercial paper, or....), and the cash would return as deposits to the Fed, and so would be automatically sterilised. This is functionally equivalent to the Fed buying long bonds (or commercial paper, or...) and paying for them with T-bills. Which in turn is close to being functionally equivalent to the Paulson plan. So, with interest on deposits, the Fed can replace the Treasury.

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