Volcker: Unclear why Fed still pays banks to park cash

Thu Sep 20, 2012 10:16pm IST

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By Pedro Nicolaci da Costa

WASHINGTON, Sept 20 (Reuters) - The Federal Reserve's policy of paying banks interest on money parked at the U.S. central bank is at odds with its latest efforts to stimulate economic growth, former Fed Chairman Paul Volcker said.

The Fed last week announced a new open-ended bond-buying program aimed at supporting the fragile U.S. economic recovery.

Volcker, who in his most recent public role was an adviser to President Barack Obama, said in an interview with Reuters TV's Impact Players on Tuesday that the Fed has limited room to boost the economy given that official interest rates are already effectively at zero.

But he said it made sense for policymakers to try to do something given the nation’s elevated jobless rate, which registered at 8.1 percent for August.

“Obviously, they reached the limits of action that has a dramatic effect,” Volcker said. “Their normal leverage has been to some extent exhausted. But they say, 'Look, we’ve still got high unemployment because the economy is still pretty sluggish, let’s put some more money into the economy.'”

Still, Volcker took issue with the Fed’s continued payment of 0.25 percent on excess bank reserves left at the central bank.

“I don’t quite understand why they’re putting all this money into the economy and then paying interest on excess reserves of the banks, which is where the banks are parking some of the money,” he said. <^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ VIDEO: Volcker interview with Robert Wolf, former CEO of UBS Americas and an economic adviser and fundraiser for Obama: bit.ly/S9m1cu and reut.rs/S9i9YJ. ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^>

The Federal Reserve declined to comment on Volcker's statements.

The Fed has suggested that cutting the interest on excess reserves is a remaining policy option, but it remains reticent to do so because of concerns that it would hurt returns on money market funds in a way that could destabilize financial markets.

Minutes of the Fed’s July 31-Aug. 1 meeting said: "While a couple of participants favored such a reduction, several others raised concerns about possible adverse effects on money markets.”

Volcker also warned that the Fed’s ultra-loose monetary policy risked stoking asset bubbles.

“That’s the danger there, which I’m sure is realized,” he said. “You put a lot more money in there, if the real engines of the economy, business investment or housing, are not moving, aren’t going to be very responsive, you may induce some kind of speculative booms.”

(Editing by Leslie Adler)

((Pedro.DaCosta@thomsonreuters.com)) Keywords: USA FED/VOLCKER

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