Selgin endorsed Hummel's criticism of Sumner's proposal to impose a penalty on excess reserves.
I think that the interest rate that the Fed pays on reserve balances should be less than zero--right now.
Consider the following:
- Private issue of currency.
- No reserve requirements.
- Frozen monetary base.
But, the base is a money market mutual fund. The shares are kept at one dollar and invested in Treasury bills. The interest return on the portfolio it transferred to the banks holding the reserves, but the banks pay a 25 basis point management free.The cost of holding reserves is the management fee. The benefit is reduced transactions costs of more active asset and liability management to continue to meet net clearing obligations. Presumably, the equilibrium demand for reserves is larger than would be the case with zero interest reserves. Less asset and liability management is necessary for the banks. Generally, the cost of financial intermediation is a bit less, the margin between the interest rates banks charge and pay is smaller, and the total size of bank balance sheets are larger.
However, the demand for reserves should still be positively related to the variance of net clearings, the amount of gross clearings, and so nominal income. The market process by which free banking stabilizes nominal income should still apply.
Further, changes in the interest rate will not change the opportunity cost of holding reserves. It will change the interest rate earned on clearing balances in proportion to changes in other interest rates.
If T-bill rates fall, then the interest rate that banks earn on their reserve balances fall too. If T-bill rates fall to something very near zero, the interest rates that banks earn on reserve balances will fall to something a bit less than zero.
It is a feature, not a bug. If interest rates on Treasury bills fall to zero, and there remains an excess demand at zero, and reserve balances have a zero interest rate, it is certainly possible, if not likely, that banks would seek to increase reserve holdings, and disrupt the market process that stabilizes nominal income. If, on the other hand, the interest rate on reserves moves with other interest rates, this will not be a problem.
Some scenarios where a free banking system would need to use the option clause would be unnecessary with interest bearing clearing balances--and those are scenarios where it is the ability of interest rates to fall, even less than zero, that avoids the disruption of using the option clause.