The Fed's Latest Gambit: Higher Interest Paid To Banks

The Federal Reserve Board just announced that it will pay higher interest rates to banks that keep excess balances with the Fed.

“Previously, the rate on excess balances had been set as the lowest federal funds rate target established by the Federal Open Market Committee (FOMC) in effect during the reserve maintenance period minus 75 basis points,” the Fed said on its website. “Under the new formula, the rate on excess balances will be set equal to the lowest FOMC target rate in effect during the reserve maintenance period less 35 basis points.”

The higher interest rates takes effect immediately.

This is meant to have the effect of easing rates without actually lowering targets. Fed funds have been trading well above the target rate as investors fled other markets. Raising the interest rates for deposits should lower the demand for Treasuries, which have lately been paying minuscule yeilds.

The Fed began paying interest on excess balances as part of its attempts to provide liquidity while bolstering its own balance sheets. It allows the Fed to new money into banks without pushing down overall interest rates.

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