Journal Article

The Federal Reserve's floor system: immediate gain for remote pain?

Mueller, Paul D., Wojnilower, Joshua

2016

Overview

The Federal Reserve's interest rate policy was insufficient, on its own, to achieve the Federal Reserve's goals during the recent financial crisis. Acquiring the legal authority to pay interest on reserves allowed the Federal Reserve to implement monetary policy using a floor system and thereby divorce interest rate policy from balance sheet policy. Although the floor system entails immediate benefits, such as eliminating the implicit tax on reserves and reducing the credit risk associated with daylight overdrafts, the remote effects include potentially large costs. More specifically, the Federal Reserve's balance sheet policies may reduce longer-run economic growth and risk the institution's independence. To maintain the floor system's present benefits, the Federal Reserve should therefore continue to implement interest rate policy through interest on reserves. To protect against the floor system's future costs, the Federal Reserve should, however, restrict its balance sheet policy to Bagehot's principles for lastresort lending.

• Publisher: Association of Private Enterprise Education
• Subject: Economic growth / Floor coverings industry / Interest rates / Monetary policy