Fed may abandon funds rate – Bernanke

The federal funds rate could become useless as a policy tool thanks to plans to increase banks’ reserves, according to testimony from Federal Reserve Board chairman Ben Bernanke.

Bernanke did not appear before the House Committee on Financial Services as planned, due to heavy snow in the Washington, DC area, but his pre-released written testimony stated “the level of activity and liquidity in the federal funds market has declined considerably, raising the possibility that the federal funds rate could for a time become a less reliable indicator than usual of conditions in short-term money markets”.

Instead, he suggested, the Fed could use a combination of the recommended level of bank reserves and the interest rate paid on excess reserves to indicate its policy target, which would be “an alternative short-term interest rate”.

This new approach could see the Federal Reserve bracket its target rate between the interest rate paid on excess reserves and the Fed discount rate, Bernanke proposed. This ‘corridor’ approach would tend to keep the funds rate within a set range: it would not rise above the discount rate because banks could simply borrow more cheaply from the Fed discount window; and it would not fall below the excess reserves rate because banks could then make a better return by depositing their cash as excess reserves.

Only users who have a paid subscription or are part of a corporate subscription are able to print or copy content.

To access these options, along with all other subscription benefits, please contact info@risk.net or view our subscription options here: http://subscriptions.risk.net/subscribe

You are currently unable to copy this content. Please contact info@risk.net to find out more.

You need to sign in to use this feature. If you don’t have a Risk.net account, please register for a trial.

Sign in
You are currently on corporate access.

To use this feature you will need an individual account. If you have one already please sign in.

Sign in.

Alternatively you can request an individual account here