As more and more button pushers suddenly realize there is a plotline behind the latest liftathon in ES, which is that the Fed may cut IOER rates to negative, here is what Goldman, and the Chairman himself, said on this topic 10 months ago. And yes: it will not happen.
Interest Rate Policy: A Dry Well
A final easing option often listed by Fed officials is a cut in the interest on excess reserves (IOER) rate—the rate that banks earn on deposits held at the Fed above levels mandated by regulation. The IOER rate is to zero (or perhaps even a negative value).
We see little merit in this option, and continue to believe that the Fed is unlikely to use it. First, the benefits are likely to be very small. While the IOER rate is 0.25%, the effective federal funds rate is only 0.08% (Exhibit 5). Thus, the maximum impact from cutting the IOER rate to zero is just 8bp.
Second, cutting the IOER rate down to zero could be harmful to market institutions. Chairman Bernanke made this argument himself in Q&A at the July 2010 Humphrey-Hawkins testimony:
“The rationale for not going all the way to zero has been that we want the short-term money markets like the Federal funds market to continue to function in a reasonable way, because if rates go to zero, there will be no incentive for buying and selling Federal funds overnight money in the banking system. And if that market shuts down, people don’t operate in that market, it will be more difficult to manage short-term interest rates when the Federal Reserve begins to tighten policy at some point in the future.”
We expect that Fed officials would hold the same view about cutting the IOER rate today. Finally, as we argued in a recent article, calls for cutting the IOER rate are partly motivated by the premise that banks are holding excess reserves because of an unwillingness to lend. In fact, the level of reserves is controlled entirely by the size and composition of the Fed’s balance sheet, and says nothing about banks’ incentives or their willingness to lend. Cutting the IOER could theoretically stimulate activity by easing financial conditions and boosting loan demand, but it would not affect the quantity of reserves in the banking system.