In considering reducing IOER, Fed policy makers are revisiting a proposal they have rejected for the past five years, even as it was recommended by economists including former Fed Vice Chairman Alan Blinder.
Blinder argued that reducing IOER would encourage banks to lend out more of the money they now keep locked up at the Fed. That would spur growth and employment as companies use cheap money to hire and invest, he argued. Fed officials disagreed, concluding that such a move wouldn’t provide a powerful boost to the economy.
“The benefits of such a step were generally seen as likely to be small except possibly as a signal of policy intentions,” according to minutes of the FOMC’s October meeting.
The Fed has been forced to turn to unconventional easing strategies after lowering its benchmark rate to zero in December 2008. It has relied on asset purchases and communications tying expectations on the outlook for interest rates to everything from the unemployment rate to calendar dates.
“They’re grasping at straws for how to signal their plans for the fed funds rate, and lowering IOER could be part of that,” said Sam Coffin, an economist in New York at UBS Securities, one of the 21 primary dealers that trades directly with the Fed.
Michael Feroli, the chief U.S. economist at JPMorgan Chase & Co., said “I’m not sure what signal” lowering IOER would send, because the benchmark federal funds rate would remain little changed.
Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey, said reducing the IOER would make Fed communications “extremely complicated” because central bankers would be wielding the repo facility -- introduced as an aid for the eventual tightening of policy -- to add stimulus.
“From an operational standpoint it alleviates some concerns that you would have really negative outcomes,” said Thomas Simons, a money-market economist at Jefferies LLC in New York, another primary dealer. “But it’s a pretty esoteric thing, very convoluted.”
Janet Yellen, the candidate to succeed Ben S. Bernanke as Fed chairman, during her confirmation hearing left open the possibility that the central bank could reduce IOER.
“It is something we could consider going forward,” Yellen, the current vice chairman, told the Senate Banking Committee on Nov. 14.