After pouring mammoth volumes of credit into the US banking system to save their economy from a catastrophic meltdown, the Federal Reserve is now planning to extract some of that liquidity. It has been signaling some credit withdrawal actions recently, and earlier this month its New York office held a live test of "reverse repos" - selling Treasuries to dealers for cash with an agreement to buy them back later at a slightly higher price. Now, it has raised the idea of paying interest on deposits to encourage banks to "invest" at the Fed for a stated time period "“ a term deposit. In this way, funds flow out of the economy and are locked up by the Fed, effectively withdrawing "excess money" that was pumped in earlier to combat the financial crisis. The Fed was given the ability in 2008 to pay interest on balances, but until now has had no programs in place to do this. The TD proposal would activate this authority. However, there is disagreement among officials as to whether programs like the reverse repos, and term deposits will be sufficient on their own to drain enough liquidity to be effective, or whether outright asset purchases "“ the traditional method "“ will also be needed. The full Fed proposal is here >>
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