Dual interest rates give central banks limitless fire power..

Eric Lonergan and Megan Greene have an interesting column in voxeu. They say most central banks have dual rates: one for lending reserves and another for absorbing reserves. In case of RBI, Repo is for former and Rev Repo for latter. But central banks mainly use one policy rate to drive changes in the economy.  This approach needs to be changed and both the rates should be used:

Normally, a central bank has to choose whether to benefit borrowers or savers when it either hikes or cuts the main policy rate. But with dual interest rates, the central bank can provide a stimulus to borrowers while also extending one to savers at the same time. In addition to cutting the lending rate deep into negative territory, the ECB could raise the average interest rate banks receive on reserves. Tiered reserves are particularly relevant here. Under a single rate regime, raising the IOR rate raises lending rates across the economy. But under tiering (such as that which the ECB has adopted), the zero rate on a portion of excess reserves could be raised to say 2% or 3%, conditional on banks passing a share of this higher interest income on to customers.


Employing dual interest rates, whereby central banks independently target bank funding rates and the interest rate of reserves with the objective of influencing deposit and lending rates independently, is a major innovation in monetary policy. Dual interest rates go beyond just targeting short-term interest rates or providing emergency liquidity to deliver an outright stimulus. This tool eliminates the effective lower bound and the risk of a liquidity trap, giving monetary policy new life in a world in which the real equilibrium interest rate is already low, is trending lower, and aggregate demand is likely to remain depressed in the wake of a pandemic and lockdown measures.

Importantly, central banks across the world already have the infrastructure in place to implement a policy of dual rates and this approach has already been used by the ECB, albeit timidly. Many developed economy central banks have tiered reserves, which allows the central bank to protect the commercial banking sector’s margins when interest rates are very low. This could also be used to encourage higher deposit rates for the private sector more broadly, without undermining the setting of interbank rates.

Some might argue that employing dual interest rates falls outside a central bank’s remit and blurs the line between monetary and fiscal policy too much. But a policy of dual interest rates falls clearly under the remit of central banks and monetary policy. It involves the creation of bank reserves (the defining feature of monetary policy) and the price of those reserves; interest rates. 

Nominal demand will prove stubbornly depressed in the post-Covid-19 and post-lockdown world, and there are already signs that fiscal authorities are beginning to drag their feet, as evidenced by the likely expiry of wage guarantees in the UK, and in the US Congress’s difficulty agreeing a fourth stimulus package. As is so often the case following a crisis, we expect governments to face increasing calls for fiscal restraint in the face of unprecedented budget deficits. With dual interest rates at their fingertips, central banks will have no excuse for staying on the sidelines and should step in with aggressive, overwhelming support.

Lonengran has an older post (2019) giving more details.


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