Federal Reserve Chair Jerome Powell defended the central bank’s ability to pay interest on commercial bank reserves during his Wednesday testimony because it remains vital for the Fed’s interest rate management system.
The Senate heard Powell state that removing the Fed’s power to pay interest would create problems with the current “ample reserves” system. The transition to a scarce reserves system would require a long and volatile journey according to Powell. “I wouldn’t recommend that.”
The interest-on-reserves policy enables the Fed to set short-term rates independently from traditional open market operations. The interest-on-reserves policy has emerged as a fundamental monetary tool for the Federal Reserve since the crisis.
Some lawmakers together with critics have raised doubts about the policy expenses and its tendency to favor large financial institutions. The policy provides monetary stability according to Powell who defended its use.
The Federal Reserve faces growing public attention regarding its financial system management and economic shock response capabilities because of rising inflation concerns and unclear fiscal policy directions.
The current structure remains unchanged because Powell stated that it would not reduce costs and would make rate-setting more complicated during this period of economic uncertainty.
