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Lesson+15a--+Interest+on+Reserves

Lesson+15a--+Interest+on+Reserves - Lesson 15a Interest on...

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Lesson 15a Interest on Reserves M&B Chapter 16 (pages 347 to 353)
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Some History Milton Friedman back in 1959 argued commercial banks should earn interest on the reserves they are statutorily required to hold on deposit at the central bank. That refrain was later picked up by the Federal Reserve . The rationale: by using open market purchases and sales of securities, the Fed adjusts the quantity of reserves banks hold and thus the interest rate they charge on excess reserves banks lend to each other (the federal funds rate). But since required reserves earn no interest, they are a tax, and like all taxes, create distortions. Over time banks minimized the portion of their deposit base subject to requirements and met a growing proportion of the remaining requirement through currency in their vaults rather than cash on deposit with the Fed. The Fed worried that eventually required reserves would be so low it would have trouble implementing monetary policy. If banks earned interest on reserves, these problems would be mitigated. Source: WSJ Blog: Fed Paying Interest on Reserves: an Old Idea With a New Urgency, April 29, 2008
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Financial Services Regulatory Relief Act of 2006 The Fed got the authority to start paying interest in October 2011 under the Financial Services Regulatory Relief Act of 2006, signed into law on Oct. 13, 2006. The reason for the late implementation was budgetary. Paying interest on reserves will reduce the amount of income the Fed
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