House Financial Services Hearing on the Fed ‘s Balance Sheet and Interest on Reserves
House Finanical Services Subcommittee on Monetary Policy and Trade
“Interest on Reserves and the Fed’s Balance Sheet”
Tuesday, May 17, 2016
Key Topics & Takeaways
- Interest on Excess Reserves: Ranking Member Gwen Moore (D-Wis.) said paying interest on excess reserves is the “only rational and predictable way to raise interest rates.” She noted that Congress gave the Federal Reserve authority to make such payments, and that many other central banks employ the same technique. Several Republicans expressed concern about paying interest on excess reserves, suggesting that it distorts the marketplace and disincentivizes lending.
- Unwinding the Fed’s Balance Sheet: Rep. Bill Foster (D-Ill.) asked if there is any limit on how rapidly the Fed should unwind its balance sheet. Eisenbeis replied that unwinding too quickly would mean selling assets at a capital loss, which could lead to insolvency and a loss of confidence in the Federal Reserve.
Witnesses
- Robert A. Eisenbeis, Vice Chairman, Cumberland Advisors
- Todd Keister, Professor of Economics, Rutgers University
- George Selgin, Senior Fellow, Cato Institute
- John B. Taylor, Mary and Robert Raymond Professor of Economics at Stanford University
Opening Statements
In his opening statement, Chairman Bill Huizenga (R-Mich.) said it had come to his attention that some on Wall Street are sending alerts that payments of interest on reserves are “under attack.” He stated that these people are “on notice” that the Committee will conduct a “thorough, complete examination” of the payments and the “tremendous amount of questions” surrounding the issue. He commented that large banks and subsidiaries of foreign banks are the biggest recipients of these payments, and that this raises concerns about impacts on community and regional banks. Huizenga stated that the Federal Reserve was authorized to pay interest on reserve in a 2006 bill, but suggested that it has not followed the “letter of the law” by paying rates above the federal funds rate, and further said this may be discouraging the free flow of credit.
Huizenga was also critical of the Fed’s balance sheet, noting that it stands at about $4.5 trillion and that it “shows no signs of shrinking.” He argued that the U.S. will not achieve robust economic growth until the Federal Reserve returns to a rule-based monetary policy, and insisted on the need for a more disciplined and transparent approach.
Ranking Member Gwen Moore (D-Wis.) said paying interest on excess reserves is the “only rational and predictable way to raise interest rates.” She noted that Congress gave the Federal Reserve authority to make such payments, and that many other central banks employ the same technique. She added that she does not believe the Federal Reserve is subsidizing the banks.
Rep. Jim Himes (D-Conn.) was very defensive of the interest payments, stressing that the Fed’s policies led to the most robust recovery among industrialized nations even as Congress “completely abdicated its role” in providing a classical fiscal stimulus.
Testimony
Robert A. Eisenbeis, Vice Chairman, Cumberland Advisors
In his testimony, Eisenbeis stressed the differences between private sector banks and the Federal Reserve. He explained how the Federal Reserve grows its balance sheet and why it is a misconception to think the Federal Reserve is making a profit when returns from investments go to the Treasury. He further discussed the need to allow the Fed to pay interest on reserves because before the payments were allowed, some private banks would opt out of the Federal Reserve System because non-interest-bearing reserves “functioned as a tax.”
Eisenbeis called the Fed’s ability to pay interest on reserves “critical” to reducing the opportunity cost of holding excess reserves and said it can help to keep interest rates, the money supply and inflation under control according to the Fed’s dual mandate.
Todd Keister, Professor of Economics, Rutgers University
Keister, in his testimony, said the ability to pay interest on reserves is an important policy tool, though admitted that the Fed has relied on this power more than it had anticipated. However, he stressed that allowing the Fed to continue using the tool is both essential to monetary policy but also sound economic policy. Keister said the payment of interest on reserves has no cost to taxpayers and is not a subsidy to banks. He argued that policymakers should encourage banks to hold excess reserves, as they are the “lifeblood” of the nation’s payments system, and that the Fed’s balance sheet should remain larger than pre-crisis levels.
George Selgin, Senior Fellow, Cato Institute
Selgin, in his testimony, said the 2006 legislation that gave the Fed the authority to pay interest on reserves was to resolve “a rather minor inefficiency” in the payments system relating to the opportunity cost incurred in being required to hold reserves that bore no interest. However, he lamented that the Fed was encouraging banks to horde reserves rather than lend, just when the economy’s total spending was collapsing, because the interest eliminated the incentive for banks to look for higher-yielding assets. Selgin argued for a return to “old-fashioned” monetary policy by unwinding the balance sheet and only allowing banks to earn interest on required reserves.
John B. Taylor, Mary and Robert Raymond Professor of Economics at Stanford University
In his testimony, Taylor discussed the growth of the Fed’s balance sheet. He said the increased supply of reserves normally drives market interest rates down, but that the Fed has prevented this by instituting interest on reserves. He said this disconnect is necessary today, but is not a good long-term proposition because it lets the Fed be a discretionary, multi-purpose institution rather than a rule-based, limited purpose institution as it was intended.
Questions and Answers
Unwindingthe Balance Sheet
Huizenga asked how the Federal Reserve could unwind its balance sheet. Eisenbeis answered that this would be difficult, as just letting the Treasury securities mature would take until about 2029 to return the balance sheet to “equilibrium.”
Rep. Bill Foster (D-Ill.) asked if there is any limit on how rapidly the Fed should unwind its balance sheet. Eisenbeis replied that unwinding too quickly would mean selling assets at a capital loss, which could lead to insolvency and a loss of confidence in the Federal Reserve.
Rep. Robert Pittenger (R-N.C.) asked what is keeping the Fed from winding down its balance sheet. Eisenbeis answered that the Fed is risk averse and very cautious about the fact that it is not achieving its inflation objective.
Taylor Rule
Huizenga commented that under the Taylor Rule, the Fed would have begun raising rates much earlier. Taylor agreed that the federal funds rate is lower today than it would be under a rule-based approach, and that this “has been a problem.”
Moore argued that the Fed has been operating under its mandate, and that the Taylor Rule “has been an intellectual discussion” rather than something the Fed has actually relied upon. Keister replied that while rates are lower than the Taylor Rule would have prescribed, the fact that the economy has recovered suggests the Fed was not wrong to keep rates low. He said any rule that may have performed well at one point will not necessarily work well in the future.
Intereston Reserves
Rep. Mick Mulvaney (R-S.C.) asked if paying interest on reserves allows the Fed to set fiscal policy. Taylor answered that it allows the Fed to take its balance sheet “any way it wants.” Selgin added that the tool has given the Fed a greater influence than needed over credit allocation.
Mulvaney asked why the Fed chose to use interest on excess reserves rather than any other tool to raise interest rates. Selgin explained that the alternative would have been to sell assets, but the Fed feared the repercussions of selling these assets for the value of its balance sheet.
Rep. Mia Love (R-Utah) said it is important to consider the impacts on working families of the Fed’s policies. Selgin responded that encouraging banks to hold reserves by paying interest on them has a drag on the economy by disincentivizing lending.
Rep. Tom Emmer (R-Minn.) commented that it does not make sense to pay interest on excess reserves, arguing that it distorts the marketplace and keeps money from being used to create new jobs.
Rep. Maxine Waters (D-Calif.) expressed her full confidence in Federal Reserve Chair Janet Yellen and her decisions relating to monetary policy and interest payments. She asked whether the benefits of quantitative easing would have been attainable without the ability to pay interest on excess reserves. Keister answered that they would not have been possible because without the ability to pay interest, the Fed would not have been able to undertake such large-scale asset purchases.
Fed Independence
Himes reiterated his comments from his opening statement, sharply criticizing Republican “Fed-bashing” and proposals that would “erode one of the cornerstones of our economy.” He warned against any effort to scale back authorities that “had everything to do with the recovery.”
For more information on this hearing, please click here.
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House Finanical Services Subcommittee on Monetary Policy and Trade
“Interest on Reserves and the Fed’s Balance Sheet”
Tuesday, May 17, 2016
Key Topics & Takeaways
- Interest on Excess Reserves: Ranking Member Gwen Moore (D-Wis.) said paying interest on excess reserves is the “only rational and predictable way to raise interest rates.” She noted that Congress gave the Federal Reserve authority to make such payments, and that many other central banks employ the same technique. Several Republicans expressed concern about paying interest on excess reserves, suggesting that it distorts the marketplace and disincentivizes lending.
- Unwinding the Fed’s Balance Sheet: Rep. Bill Foster (D-Ill.) asked if there is any limit on how rapidly the Fed should unwind its balance sheet. Eisenbeis replied that unwinding too quickly would mean selling assets at a capital loss, which could lead to insolvency and a loss of confidence in the Federal Reserve.
Witnesses
- Robert A. Eisenbeis, Vice Chairman, Cumberland Advisors
- Todd Keister, Professor of Economics, Rutgers University
- George Selgin, Senior Fellow, Cato Institute
- John B. Taylor, Mary and Robert Raymond Professor of Economics at Stanford University
Opening Statements
In his opening statement, Chairman Bill Huizenga (R-Mich.) said it had come to his attention that some on Wall Street are sending alerts that payments of interest on reserves are “under attack.” He stated that these people are “on notice” that the Committee will conduct a “thorough, complete examination” of the payments and the “tremendous amount of questions” surrounding the issue. He commented that large banks and subsidiaries of foreign banks are the biggest recipients of these payments, and that this raises concerns about impacts on community and regional banks. Huizenga stated that the Federal Reserve was authorized to pay interest on reserve in a 2006 bill, but suggested that it has not followed the “letter of the law” by paying rates above the federal funds rate, and further said this may be discouraging the free flow of credit.
Huizenga was also critical of the Fed’s balance sheet, noting that it stands at about $4.5 trillion and that it “shows no signs of shrinking.” He argued that the U.S. will not achieve robust economic growth until the Federal Reserve returns to a rule-based monetary policy, and insisted on the need for a more disciplined and transparent approach.
Ranking Member Gwen Moore (D-Wis.) said paying interest on excess reserves is the “only rational and predictable way to raise interest rates.” She noted that Congress gave the Federal Reserve authority to make such payments, and that many other central banks employ the same technique. She added that she does not believe the Federal Reserve is subsidizing the banks.
Rep. Jim Himes (D-Conn.) was very defensive of the interest payments, stressing that the Fed’s policies led to the most robust recovery among industrialized nations even as Congress “completely abdicated its role” in providing a classical fiscal stimulus.
Testimony
Robert A. Eisenbeis, Vice Chairman, Cumberland Advisors
In his testimony, Eisenbeis stressed the differences between private sector banks and the Federal Reserve. He explained how the Federal Reserve grows its balance sheet and why it is a misconception to think the Federal Reserve is making a profit when returns from investments go to the Treasury. He further discussed the need to allow the Fed to pay interest on reserves because before the payments were allowed, some private banks would opt out of the Federal Reserve System because non-interest-bearing reserves “functioned as a tax.”
Eisenbeis called the Fed’s ability to pay interest on reserves “critical” to reducing the opportunity cost of holding excess reserves and said it can help to keep interest rates, the money supply and inflation under control according to the Fed’s dual mandate.
Todd Keister, Professor of Economics, Rutgers University
Keister, in his testimony, said the ability to pay interest on reserves is an important policy tool, though admitted that the Fed has relied on this power more than it had anticipated. However, he stressed that allowing the Fed to continue using the tool is both essential to monetary policy but also sound economic policy. Keister said the payment of interest on reserves has no cost to taxpayers and is not a subsidy to banks. He argued that policymakers should encourage banks to hold excess reserves, as they are the “lifeblood” of the nation’s payments system, and that the Fed’s balance sheet should remain larger than pre-crisis levels.
George Selgin, Senior Fellow, Cato Institute
Selgin, in his testimony, said the 2006 legislation that gave the Fed the authority to pay interest on reserves was to resolve “a rather minor inefficiency” in the payments system relating to the opportunity cost incurred in being required to hold reserves that bore no interest. However, he lamented that the Fed was encouraging banks to horde reserves rather than lend, just when the economy’s total spending was collapsing, because the interest eliminated the incentive for banks to look for higher-yielding assets. Selgin argued for a return to “old-fashioned” monetary policy by unwinding the balance sheet and only allowing banks to earn interest on required reserves.
John B. Taylor, Mary and Robert Raymond Professor of Economics at Stanford University
In his testimony, Taylor discussed the growth of the Fed’s balance sheet. He said the increased supply of reserves normally drives market interest rates down, but that the Fed has prevented this by instituting interest on reserves. He said this disconnect is necessary today, but is not a good long-term proposition because it lets the Fed be a discretionary, multi-purpose institution rather than a rule-based, limited purpose institution as it was intended.
Questions and Answers
Unwindingthe Balance Sheet
Huizenga asked how the Federal Reserve could unwind its balance sheet. Eisenbeis answered that this would be difficult, as just letting the Treasury securities mature would take until about 2029 to return the balance sheet to “equilibrium.”
Rep. Bill Foster (D-Ill.) asked if there is any limit on how rapidly the Fed should unwind its balance sheet. Eisenbeis replied that unwinding too quickly would mean selling assets at a capital loss, which could lead to insolvency and a loss of confidence in the Federal Reserve.
Rep. Robert Pittenger (R-N.C.) asked what is keeping the Fed from winding down its balance sheet. Eisenbeis answered that the Fed is risk averse and very cautious about the fact that it is not achieving its inflation objective.
Taylor Rule
Huizenga commented that under the Taylor Rule, the Fed would have begun raising rates much earlier. Taylor agreed that the federal funds rate is lower today than it would be under a rule-based approach, and that this “has been a problem.”
Moore argued that the Fed has been operating under its mandate, and that the Taylor Rule “has been an intellectual discussion” rather than something the Fed has actually relied upon. Keister replied that while rates are lower than the Taylor Rule would have prescribed, the fact that the economy has recovered suggests the Fed was not wrong to keep rates low. He said any rule that may have performed well at one point will not necessarily work well in the future.
Intereston Reserves
Rep. Mick Mulvaney (R-S.C.) asked if paying interest on reserves allows the Fed to set fiscal policy. Taylor answered that it allows the Fed to take its balance sheet “any way it wants.” Selgin added that the tool has given the Fed a greater influence than needed over credit allocation.
Mulvaney asked why the Fed chose to use interest on excess reserves rather than any other tool to raise interest rates. Selgin explained that the alternative would have been to sell assets, but the Fed feared the repercussions of selling these assets for the value of its balance sheet.
Rep. Mia Love (R-Utah) said it is important to consider the impacts on working families of the Fed’s policies. Selgin responded that encouraging banks to hold reserves by paying interest on them has a drag on the economy by disincentivizing lending.
Rep. Tom Emmer (R-Minn.) commented that it does not make sense to pay interest on excess reserves, arguing that it distorts the marketplace and keeps money from being used to create new jobs.
Rep. Maxine Waters (D-Calif.) expressed her full confidence in Federal Reserve Chair Janet Yellen and her decisions relating to monetary policy and interest payments. She asked whether the benefits of quantitative easing would have been attainable without the ability to pay interest on excess reserves. Keister answered that they would not have been possible because without the ability to pay interest, the Fed would not have been able to undertake such large-scale asset purchases.
Fed Independence
Himes reiterated his comments from his opening statement, sharply criticizing Republican “Fed-bashing” and proposals that would “erode one of the cornerstones of our economy.” He warned against any effort to scale back authorities that “had everything to do with the recovery.”
For more information on this hearing, please click here.