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Paying Interest on Reserve Balances: It's More Significant than You Think

7 Pages Posted: 12 Dec 2010  

Scott T. Fullwiler

Wartburg College; Bard College - The Levy Economics Institute

Date Written: December 1, 2004

Abstract

It has long been recognized that uncompensated reserve balances act like a tax on banks and that banks as a result expend scarce resources to avoid holding them. The Fed itself has historically supported legislation to enable it to pay interest on reserve balances (e.g., Kohn 2003), as have economists (e.g., Goodfriend 2002), both for reasons of economic efficiency and to improve the implementation of monetary policy. The traditional argument against interest payment has been that it would reduce the Fed’s earnings that are subsequently turned over to the Treasury (Feinman 1993b; Abernathy 2003). The purpose of this paper is to demonstrate the implications of paying interest on reserve balances on the daily operations of both the Fed and the Treasury. While the arguments here - for different reasons - generally are in favor of enabling the Fed to pay interest on reserve balances, more important than the actual payment of such interest is the perspective gained when considering in detail the operations of both in an environment where reserve balances earn interest.

Keywords: interest on reserves, central bank operations

JEL Classification: E42, E43, H63

Suggested Citation

Fullwiler, Scott T., Paying Interest on Reserve Balances: It's More Significant than You Think (December 1, 2004). Available at SSRN: https://ssrn.com/abstract=1723589 or http://dx.doi.org/10.2139/ssrn.1723589

Scott T. Fullwiler (Contact Author)

Wartburg College ( email )

222 Ninth St. NW
Waverly, IA 50677
United States

Bard College - The Levy Economics Institute ( email )

Blithewood
Annandale-on-Hudson, NY 12504-5000
United States

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