Fed Proposes Bank Deposits to Soak Up Money in System

WASHINGTON—The Federal Reserve on Monday proposed allowing banks to set up the equivalent of certificates of deposit at the central bank, a move to help the Fed mop up money pumped into the economy to prevent inflation from taking off later. Under the proposal, the Fed would offer "term deposits" that would pay interest. Doing so would provide banks with another incentive to park their money at the Fed, rather than having it flow back into the economy. The proposal comes as no surprise. Fed Chairman Ben Bernanke and other Fed officials have repeatedly said the creation of such deposits would be one of several tools the Fed could use to drain money from the economy when the time is right. Against that backdrop, the Fed said the proposal "has no implications for monetary policy decisions in the near term." With both the economy and the financial system on the mend, the Fed this year started to wind down and scale back some emergency lending programs. Many of those programs were set up during the height of the financial crisis in the fall of 2008 when some credit markets virtually shut down. Lending conditions have improved but still aren't back to normal. They continue to restrain the economic recovery. The Fed's balance sheet has ballooned to more than $2 trillion, reflecting the creation of lending programs intended to ease the financial crisis. That's more than double what it was before the crisis struck. The Fed will need to mop up that money or it could trigger inflation down the road. The Fed proposed that the interest rate paid on the term deposit be set through an auction mechanism. Banks wanting to hold a term deposit would bid in regularly scheduled competitive auctions. The banks would indicate both the interest rate at which they are willing to be paid and the amount of money they want to deposit into the account at that interest rate. Given that process, it's unclear now what the rates on the accounts would be. The Fed said it anticipated term deposits with "relatively short maturities" likely ranging between one and six months. It said deposit maturities wouldn't exceed one year, and no early withdrawals of money in the accounts would be allowed. The public, the banking industry and other interested parties will be given an opportunity to weigh in on the proposal. The plan could be revised before a final rule is adopted. Most economists don't believe the Fed will start raising its key bank lending rate, which also influences a range of consumer lending rates, until the middle of next year. The Fed at its meeting earlier this month kept rates at a record low and pledged to hold them there for an "extended period" to foster the recovery.