I heard a guest on Larry Kudlow say something about how the fed is going to start trying to control interest rates by adjusting what it pays out on the reserves that commercial banks hold with them. How would this work? And what is the purpose for the fed paying interest on the reserves anyway?
There are several questions here:
First, the Fed ‘targets’ the rate that banks loan to each other to borrow to meet reserve requirments.
Its helpful to understand that very little of most banks ‘reserves’ are actually kept in cash. Most of it is kept in essencially a checking account at the Fed(which is as good as cash, since the Fed can print up the money to cover it at a moments notice). The Fed recently began a policy of paying interest on accounts at the Fed(like your bank does with your savings account). Basically the idea is if banks start loaning out too much and inflation becomes a problem, the Fed will raise the rate of interest they are paying on Fed accounts. Effectively the Fed is going to pay banks to not loan out money , and instead keep their money in reserve with the Fed. (and no this is not a joke).
As for the purpose of it, it depends: A cynical person will say that its one more way to enrich the banking cartel while screwing over everybody else. Fed apologists will say its one more ‘tool’ the Fed can use to ‘steer’ the economy.