The US Federal Reserve plans to offer term deposits to banks as part of its “exit strategy” from the exceptionally loose monetary policy used to fight the recession.
In a consultation paper released on Monday the Fed said it planned to change its rules so that it could pay interest on money locked up at the central bank for a defined period.
The Fed added that the well-flagged rule change - designed to allow it more influence over the $1,100bn in excess reserves held by banks - was part of “prudent planning…and has no implications for monetary policy decisions in the near term”.
It is one of a number of measures that has been outlined over the past few months by Ben Bernanke, chairman of the Fed, as an option to drain liquidity from the financial system in a manner that protects the economic recovery while heading off the threat of inflation.
The period over which interest would be paid would be less than a year and probably between one and six months, the Fed said, while the rate would be determined by an auction.
The Fed said this month that it continued to expect to keep interest rates at ”exceptionally low levels” for an ”extended period”. Most economists believe there will be no increase from the near-zero policy until the middle of 2010.
Earlier this month the New York Fed conducted its first live test of “reverse repos”- or reverse repurchase agreements - selling assets such as Treasuries to dealers for cash with an agreement to buy them back later at a slightly higher price.
By draining reserves, both reverse repos and term deposits prevent excess money from entering the broader economy.
Some Fed officials believe outright asset sales might be necessary to drain liquidity while others think reverse repos and term deposits should be sufficient.
Morten Bech and Elizabeth Klee, both Fed officials, published a paper this month that suggested that if the Fed tightens policy it “could use some combination” of paying interest on bank reserves - authority granted last year - coupled with “tools to drain reserves such as term deposits or reverse repurchase agreements”.
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