Bruce Bartlett has been discussing what the Fed can do to help stabilize aggregate demand. In this piece he joins the growing chorus of observers calling for the Fed to abolish paying interest on banks' excess reserves:
[M]any economists believe that the Fed has unwittingly encouraged banks to sit on their cash and not lend it by paying interest on reserves. Eliminating interest on reserves would therefore encourage lending. A rumor that the Fed might do so caused the stock market to rise earlier this week, according to press reports. But the policy remains in place.
To use a hackneyed phrase, the Fed needs to think outside the box and be more innovative and aggressive about getting money to circulate, getting banks to lend, and raising inflationary expectations. Ending payments to banks on money they aren’t lending would be a step in the right direction.
I agree and have been making this same point since October 2008 when the Fed first started this policy. At this juncture, though, the Fed should also add some explicit nominal target--my favorite would be a nominal GDP target--to stabilize nominal expectations and shore up velocity. As I have said before--and contrary to what Bruce Bartlett claims in his other Fed piece--there is a lot monetary policy can do now to stabilize aggregate demand if it wanted to do so.