Robert Hall and Susan Woodward posted an essay on the subject of interest on reserves:
Raising the reserve interest rate is a contractionary measure. A higher interest rate on reserves makes banks more likely to hold reserves rather than increasing lending. The Fed’s decision to raise the reserve rate from zero to 75 basis points just as the economy entered a sharp contraction in activity is utterly inexplicable. Fortunately, the Fed lowered the reserve rate subsequently, but the continuation of a positive reserve rate in today’s economy is equally inexplicable. Some economists have proposed that the Fed charge banks for holding reserves, an expansionary policy worth considering. With the Fed funds rate at around 15 basis points, it would take a charge to restore the differential that drives banks to lend rather than hold reserves. Were the Fed to charge for reserves, they would become the hot potatoes that they were in the past, when the reserve rate was zero and the Fed funds rate 4 or 5 percent. Banks would expand lending to try not to hold the hot potatoes and the economy would expand. There is no basis for the claim that the Fed has lost its ability to steer the economy. (However, the Fed would have to go to Congress to get this power, as it did to get the power to pay positive interest on reserves.) [italics in original]
BTW, I am not suggesting that they are referring to this blog, as I’m sure other economists are also making this argument, but I’d like to think we might be having some impact on the conversation. I sent an email to Robert Hall a couple weeks ago.
Thanks to Dilip for two very helpful links. This one, and yesterday’s link to Brad DeLong. BTW, Andrew Sullivan just linked to the global warming post. Make that three, Dilip just sent me the link below.
Update: Mark Thoma just linked to the Hall and Woodward idea here. Mark calls their essay “good, but wonkish,” although it’s not clear if that refers to the interest penalty idea.