Joshua R. Hendrickson suggests that paying interest on excess reserves at the Fed reduces the effectiveness of monetary policy. Money paid to purchase Treasuries finds its way back to the Fed in the form of excess reserves. Here is the abstract from his paper:
Over the last several years, the Federal Reserve has conducted a series of large scale asset purchases. The effectiveness of these purchases is dependent on the monetary transmission mechanism. Federal Reserve chairman Ben Bernanke has argued that large scale assets purchase are effective because they induce portfolio reallocations that ultimately lead to changes in economic activity. Despite these claims, a large fraction of the expansion of the monetary base is held as excess reserves by commercial banks. Concurrent with the large scale asset purchases, the Federal Reserve began paying interest on reserves and enacted changes in its Payment System Risk policy that have effectively made reserves and interest-bearing assets perfect substitutes. This paper demonstrates that these policy changes have had statistically and economically significant effects on the demand for reserves and simply that the effectiveness of conventional monetary policy has been significantly weakened.
Read the entire paper at Interest on Reserves, Settlement, and the Effectiveness of Monetary Policy |
Joshua R. Hendrickson.