I'm going to need some help with this one, fellas. It's being reported that the FOMC is considering raising the level of interest paid on excess reserves as a means to keep banks from lending and forestall inflation. I'm sorry, but as a student of the Austrian school of economic theory, my mind just doesn't work that way. I'm going to need a dyed-in-the-wool Keynesian to sort this out for me.
Here's the problem (as I understand it): after letting the beast of excess liquidity off the chain, the Fed is finding that they can no longer effectively manipulate the economy with the Fed Funds Rate. They're concerned about rising inflation because the banks have access to so much (Fed provided) liquidity. The Fed wants to be able to curb bank lending, so the plan is to offer a better rate of interest on excess reserves to convince the banks to leave their excess reserves on deposit at the Fed instead of lending them out.
Here is where it gets squirelly for me. The Fed either gave these excess reserves to the banks through the purchase of worthless toxic assets, or the Fed loaned these excess reserves to the banks at the ridiculous rate of 25 basis points. In either case, the Fed has basically given away the money. Now the plan is to pay the banks even more to prevent them from loaning the money out?
First of all, the banks aren't lending money as it is. Not in any meaningful way, anyway. I guess I can accept that the powers that be are content to see a jobless recovery, despite the damage that does to a significant portion of the American population. But this proposal has the potential to go way beyond killing inflation. It could put a hammerlock on the economy and keep us at marginal GDP growth indefinitely.
Wouldn't a better policy be to just bite the bullet and raise the Fed funds rate to something respectable like 3%? Yes, it would cause a great deal of short term pain, but you don't go on a coke bender in a Shanghai brothel and expect to feel fine in the morning.
I'm being serious here, guys. Somebody explain the advantage of this proposed plan to me. Please.