Fed Chairman Powell Warns of Volatility in Dropping Power to Pay Interest on Reserves

Federal Reserve Chairman Jerome Powell cautioned on June 25 that stripping the central bank of its power to pay interest on reserves would be a long and difficult process, potentially leading to significant volatility in the financial system. Powell's remarks come as some lawmakers, including Sen. Ted Cruz, have pushed for the Fed to relinquish its power to pay interest on reserves, citing potential savings for the central bank.

Key Takeaways:

• The Fed's power to pay interest on reserves was implemented in 2008 as a response to the financial crisis, allowing the central bank to pay deposit-taking banks interest for cash they park on the Fed's books.
• The power, set at 4.4%, currently binds the top end of the federal funds rate, while the reverse repo rate, now at 4.25%, puts a floor underneath the central bank's target.
• Fed Chairman Powell warned that stripping the power to pay interest on reserves would be "a long and bumpy and volatile road," and could drive considerable sums of cash into the reverse repo facility, leading to significant interest-related costs.
• Powell stated that removing the power in the absence of other action would upend the Fed's ability to manage short-term rates and could require the central bank to aggressively shed bonds it owns.
• New York Fed President John Williams said the power is "an absolutely essential way for us to control interest rates and carry out the monetary policy we need to achieve our maximum employment and price stability goals."
• Powell emphasized that the Fed's ability to achieve its policy goals is not affected by its profits and losses, and that relinquishing the power to pay interest on reserves would not save money.

Statistics:

• The Fed's interest on reserves tool is set at 4.4%.
• The reverse repo rate is now at 4.25%.
• Federal Reserve Chairman Jerome Powell was speaking on June 25.
• New York Fed President John Williams made comments on June 24.

Sources:

• Reuters, Federal Reserve Chairman Jerome Powell, June 25, 2023
• New York Fed President John Williams, interview with Reuters, June 24, 2023
• Senate testimony by Federal Reserve Chairman Jerome Powell, June 25, 2023