The Federal Reserve’s Floor System: Immediate Gain for Remote Pain?

The Journal of Private Enterprise, 31(2): 15-40, 2015

33 Pages Posted: 4 Aug 2014 Last revised: 6 Feb 2019

See all articles by Paul Mueller

Paul Mueller

George Mason University

Joshua Wojnilower

Independent Evaluation Office of the IMF

Date Written: July 13, 2015

Abstract

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 last-resort lending.

Keywords: Federal Reserve, Financial Crisis, Floor System, Interest on Reserves, Interest Rates, Monetary Policy

JEL Classification: E52, E58, G21

Suggested Citation

Mueller, Paul and Wojnilower, Joshua, The Federal Reserve’s Floor System: Immediate Gain for Remote Pain? (July 13, 2015). The Journal of Private Enterprise, 31(2): 15-40, 2015, Available at SSRN: https://ssrn.com/abstract=2475237 or http://dx.doi.org/10.2139/ssrn.2475237

Paul Mueller (Contact Author)

George Mason University ( email )

4400 University Drive
Fairfax, VA 22030
United States

Joshua Wojnilower

Independent Evaluation Office of the IMF ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

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