The hottest topic in monetary policy right now is negative interest rates.
The Bank of Japan took rates negative last month, joining the European Central Bank and others, with over 20% of the world’s GDP now covered by at least some negative rate policy exists.
This had led to the question of whether the Federal Reserve, the most powerful and closely-watched central bank in the world, will follow suit.
But there might be some legal hurdles to overcome.
On Wednesday, Fed chair Janet Yellen was asked by Rep. Patrick McHenry (R-North Carolina) about the Fed’s legal authority to make rates negative. And, well, it’s unclear.
Yellen told McHenry (emphasis ours):
“In the spirit of prudent planning we always try to look at what options we would have available to us either if we needed to tighten policy more rapidly than we expect or the opposite. So we would take a lot at [negative rates]. The legal issues I’m not prepared to tell you have been thoroughly examined at this point. I am not aware of anything that would prevent [the Fed from taking interest rates into negative territory]. But I am saying we have not fully investigated the legal issues.”
McHenry’s question referenced press reports — likely Matt Boesler’s report at Bloomberg News — that questioned whether the Fed has the legal standing to make interest rates negative.
As Boesler reported, an August 5, 2010 Fed staff memo found:
There are several potentially substantial legal and practical constraints to implementing a negative IOER rate regime, some of which would be binding at any IOER rate below zero, even a rate just slightly below zero. Most notably, it is not at all clear that the Federal Reserve Act permits negative IOER rates, and more staff analysis would be needed to establish the Federal Reserve’s authority in this area.
Among the concerns raised by the Fed is that were its IOER rate — or interest on excess reserves, which is the upper-band of the two-interest-rate program the Fed currently uses to push the Fed Funds rate into the Fed’s targeted range — to go into negative territory, Treasury auctions could run into problems because US government debt cannot currently be issued at a negative yield.
Elsewhere in Yellen’s testimony, the IOER rate — which currently sits at 0.50% — got quite a bit of attention as at least two members of the Committee asked whether this rate was a “subsidy” to US banks who earn this rate on reserves at the Fed.
Yellen noted that this formulation isn’t quite right given that these banks pay out an even higher rate to their customers.
Additionally, these reserves are part of what allows the Fed to hold such a large stock of assets, the interest from which is paid back to the Treasury at a much higher rate than what the Fed pays out to banks.
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