By Pedro Nicolaci da Costa
WASHINGTON, Dec 28 (Reuters) – The U.S. Federal Reserve on Monday proposed the creation of a new mechanism it could use to withdraw money from the banking system when the time comes to tighten monetary policy.
The mechanism, known as a term deposit facility, would allow financial institutions to earn interest on loans of longer maturities to the central bank. The Fed already pays interest on banks’ overnight reserves.
Rates on such loans could be determined at auction or via a specified formula, the Fed said. Their length would not exceed one year, but would most likely range from one to six months.
In its effort to battle the worst financial crisis since the Great Depression, the Fed has deployed an extraordinary array of emergency measures, leading to a surge in outstanding credit to the banking system to nearly $2.2 trillion.
These measures have fueled some concern about the possibility of high inflation, since withdrawing such reserves at just the right time is seen as crucial to preventing rapid growth in consumer prices.