| SAN FRANCISCO, June 12
SAN FRANCISCO, June 12 The U.S. Federal Reserve
should suspend payments to the Treasury to avoid a potential
cash crunch when the time comes to raise interest rates,
according to former Richmond Fed policy adviser Marvin
Such a reversal in policy is critical to protecting the
Fed's inflation-fighting credibility, Goodfriend said in an
interview Thursday, because otherwise the central bank will find
itself needing to print money to pay for its obligations as it
raises interest rates, an untenable situation in his view.
"It's not good idea for a central bank to ever put itself in
the position of having to create money to stabilize the value of
money against inflation," said Goodfriend, now an economics
professor at Carnegie-Mellon University. "You are throwing fuel
on the fire."
The U.S. central bank has sent about $320 billion to the
Treasury since 2010. The money comes from interest earned on the
Fed's massive portfolio of bonds acquired in its ongoing effort
to push down borrowing costs and boost the economy.
The Fed pays for those bond purchases by creating reserves
in the accounts of banks that hold funds at the Fed. When the
time comes to raise rates from their current near-zero level,
the central bank plans to prevent those reserves from flooding
back into the financial system by raising the rate of interest
it pays on them.
Economists have previously flagged the possibility that
doing so could reduce the amount of money the Fed sends to the
Treasury, while boosting the Fed's payments to banks, creating
what some central bankers have called an "optics" problem.
Goodfriend points to another danger: the possibility that if
rates rise high enough, to 3.75 percent, the Fed will no longer
make enough money on its interest income to cover its rising
interest payments to banks.
The issue is not potential insolvency; the Fed can print
money by creating reserves. The issue, according to Goodfriend,
is in creating new reserves in order to pay banks interest on
existing reserves. "The credibility of the Fed's anti-inflation
policy would be jeopardized," he said in a paper presented at a
Bank of Japan conference late last month.
The Fed could have avoided the problem, Goodfriend said, if
it had recognized its bond-buying stimulus for what it is - a
massive "carry trade" by which the Fed created reserves to
finance its purchases of bonds, which generate higher interest.
Firms running such a strategy typically retain profits made
at the outset to cover the losses they will likely encounter
when the trade is eventually unwound, Goodfriend explained. The
Fed, however, has been transferring its profits to the Treasury,
leaving it with a too-thin cushion against eventual losses, he
If the Fed starts retaining its earnings now, he said, it
could build a $60 billion buffer by next March, enough to make a
meaningful difference in preventing a cash crunch.
(Editing by Eric Walsh)