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Dear Mark, I'm totally agree with you on this You should look at Japan as a perfect example on what would happen if Central Bank stopped paying interest rate on excess bank's reserve. The result would be, interbank rate (Fed Fund Rate in US) would be pushed down to zero percent! That's all and nothing more will happen, (again, using Japan as an example). Fed doesn't need to use Quantitative Easing to achieve this zero interest rate at this stage since American banks do not face any shortage of reserves. The Fed could just simply declare that they will no longer support the current rate and there is no mere "Fed Fund Target Rate" that will be targeted. At this current stage (with excess reserve among US banks) Open market operations is redundant and no longer useful to achieve the zero rate. Fed could just simply - declare that there is no longer Fed Fund Target Rate and lets the market determined the Fed Fund Rate. Access reserves among banks created by "Treasury deficit spending" and "lack of demand from borrowers" are enough to pushed the interest rate down to zero if Fed just declare that they no longer will pay any interest and Fed would let the rate be determined by the market. What happen if Fed is paying zero interest?? Maybe there will only be a small increase in borrowing (Japan has gone through all this), and not significant impact on US economy because there would never be any sufficient demand for credit by the private borrowers . . . The only policy left - FISCAL intervention (not tax cut) but more govt spending.
Toggle Commented Jul 9, 2010 on A Response to Arnold Kling at Economist's View
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