If you've spent much time at all on these pages, you know that my favorite hobby-horse for several years now has been the Federal Reserve's policy of paying interest on (banks') excess reserves (IOER) at an above-market rate. By adopting that policy in October 2008, the Fed replaced the operating system that had seen it through the Great Moderation with a "floor"-type system in which banks are kept awash in excess reserves, and monetary policy is conducted by adjusting the Fed's IOER rate.
Although I've criticized various aspects of the floor system in numerous posts here, as well as in several op-eds and in testimony before the House Financial Services Committee, I realized some time ago that the workings of the floor system, and especially the subtle ways in which it tends to undermine the Fed's ability to combat recession and control inflation, call for a more systematic exposé.
And so, my new Cato book, FLOORED!: How a Misguided Fed Experiment Deepened and Prolonged the Great Recession, and Why the Fed – or Congress – Ought to End It. Among other things, FLOORED! explains how the Fed's new operating system
- intensified an already severe economic downturn by serving as the means by which the Fed maintained an excessively tight monetary policy;
- led to a sustained collapse in the interbank market for federal funds, thereby destroying the Fed's traditional means of monetary control;
- dramatically reduced the effectiveness of open-market operations, so that even massive Fed asset purchases might not supply the stimulus to investment and spending that much smaller purchases would once have achieved;
- undermined productivity by substantially increasing the Fed's role in allocating scarce credit; and
- made it more difficult for the Fed to reach its 2 percent inflation target.
Although FLOORED! is scheduled for publication as a proper book later this spring, we're releasing it today as a Cato-CMFA Working Paper, so as to elicit comments and criticism from readers like yourself, and also from others with an interest in the subject. So please let me have your reactions, and pass the link on to anyone you know who may have thoughts to share with me on its subject.
So what are you waiting for? Get FLOORED!