Federal Reserve

Fed's Williams: Cutting rate on banks' reserves 'would make sense'

John Williams, president of the Federal Reserve Bank of San Francisco.
Andrew Harrer | Bloomberg | Getty Images

The Federal Reserve has more reason than ever to cut a key U.S. lending rate it has kept at just above zero since the depths of the financial crisis, a top Fed policymaker suggested on Tuesday.

The Fed set the interest rate it pays banks on their excess reserves at 0.25 percent when it introduced it in 2008, and it has sat there ever since.

Investors have lately been abuzz with speculation that the Fed could cut that rate as a way to signal its seriousness about keeping interest rates low even after it reduces its $85 billion-a-month bond-buying stimulus program.

"As everybody says, it's not going to be a game changer, but given that we're doing a lot of unconventional policy and pushing hard, I think it would make sense," San Francisco Federal Reserve Bank President John Williams told Reuters in an interview. "If you can get the funds rate trading a little lower and bring down interest rates a little lower, that's a positive."

(Read more: Will strong data hasten the taper?)

Williams is a strong supporter of the Fed's bond-buying program. On Tuesday, he said he believes that the Fed needs to do more to prove it is committed to keeping short-term rates low as long as needed to support the recovery.

Will remain accommodative, tools will change: Fed's Lockhart
Will remain accommodative, tools will change: Fed's Lockhart

Most importantly, he said, the Fed should give better guidance on what would induce it to raise rates once the U.S. unemployment rate falls to 6.5 percent, the level at which the Fed said has said it would consider an interest-rate hike.

Williams participates in the meetings of the policymaking Federal Open Market Committee, but he will not become a voting member of the FOMC until 2015.

The rate the Fed paid on excess reserves is distinct from the Fed's main policy rate, which it has kept at between zero and 0.25 percent for nearly five years.

But reducing that rate could force more money into the broader financial system in the form of loans to stimulate investment, hiring and economic growth. Banks keep about $2.5 trillion in excess reserves.

(Read more: Banks hit with $2.3 billion rate-rigging fine)

"Most participants" at the Fed's latest policy-setting meeting thought lowering the rate was "worth considering at some stage," according to minutes of the meeting released last month.

Critics worry whether money markets can still function if rates fall to zero; indeed, over the years, the Fed has considered and rejected the idea of reducing the rate in part because of that very concern.

But a new central bank tool blunts that risk, Williams said on Tuesday.

Known as a fixed-rate full-allotment reverse repo facility, the tool has been touted as a way to mop up excess cash in the financial system once the Fed needs to start raising rates. 1/8ID: nL2N0JH20N 3/8

But it could also be helpful should the Fed decide to lower the rate it pays to banks, Williams said.

(Read more: Lock it down: Mortgage rates on the rise again)

"We do have this ability through this reverse repo that's been tested by the New York Fed that basically makes sure we can control short-term interest rates even if we ... lowered the interest on reserves closer to zero," Williams said.

Still, Williams did not suggest the idea is necessarily on the Fed's front burner.

"On the margin, I thought the pros slightly outweigh the cons," he said. "Obviously, that's not what we are doing. It's been an issue we've discussed several times over the years. It's always been part of that mix: 'How do you weigh the costs and benefits?"'

By Reuters