The U.S. Federal Reserve on Monday pressed ahead toward the creation of a new mechanism it says could be used to withdraw money from the banking system once policymakers decide to tighten monetary policy.
The program, called the term deposit facility, would allow financial institutions to earn interest on loans of longer maturities to the central bank. The Fed already pays interest on banks' overnight reserves.
Term deposits would be one of several tools that the Federal Reserve could employ to drain reserves to support the effective implementation of monetary policy, the Fed said in a statement that was the Fed's first detailed proposal for the new facility.
Rates on term loans, whose maturity would likely range between one and six months and would not exceed a year, could be determined via competitive bidding at auction, the Fed said. They would be available only to financial institutions eligible for federal deposit insurance, not the general public. Once lent to the central bank, the money cannot be withdrawn.
In its effort to battle the worst financial crisis since the Great Depression, the Fed has deployed an extraordinary array of emergency measures, leading to a surge in outstanding credit to the banking system to more than $2.2 trillion.
The amount of money sloshing around has fueled concern about the possibility of high inflation. Withdrawing the reserves at just the right time is seen as crucial to keep consumer prices under wraps.
They have a big problem with excess reserves and this is one of the ways to deal with it, said Raymond Remy, head of fixed-income at Daiwa Securities.
The latest proposal, which the Fed stressed did not represent an immediate move toward a less accommodative monetary policy, was expected to serve as an additional tool in the tightening arsenal, which also includes reverse repurchase agreements and outright sales of assets.
The proposal is one component of a process of prudent planning on the part of the Federal Reserve and has no implications for monetary policy decisions in the near term, the Fed said in a statement.
The central bank has requested feedback on its proposal from market participants, which should help inform the ultimate structure of term deposits.
At the height of last year's financial meltdown, the Fed had been discussing going to Congress to request the authority to issue its own bills. The term deposit facility achieves a similar purpose, but can be undertaken within the Fed's existing authority and does not require congressional approval.
This is more of a politically acceptable way of getting the same thing done, said Tom Simons, money market economist at Jefferies.
(Additional reporting by Emily Flitter in New York)