The government would actually make money within three years if the Federal Reserve started paying interest on bank reserves, according to an industry analysis.
Looking to bolster support for the move, the American Bankers Association released a study showing that initial costs of $400 million would be recouped by 2006.
"We want to dispel the myth that paying interest on reserves will be a budget buster," said James Chessen, the ABA's chief economist. "It is not. In fact, it is a budget booster."
The ABA sent the analysis to several congressional staffers last week and plans to show it to Fed officials this week.
The study comes on the heels of calls by Senate Banking Committee Chairman Alfonse M. D'Amato and House Banking Committee member Jack Metcalf for legislation allowing the Fed to pay interest on reserves.
Banks are sweeping checking and savings account deposits into money market mutual funds to reduce the amounts they must hold interest-free at the Fed. As a result, reserve balances at the Fed have fallen substantially.
Fed economists, worried about the impact on monetary policy, first raised alarms last summer. Banks increased their use of sweep accounts tenfold from January 1995 to May 1996, the Fed said, pushing reserve balances down to $16.1 billion, a 30-year low. Reserve levels continued to decline from July 1996 through January 1997, and stood at $11.7 billion in January.
Fed Chairman Alan Greenspan has repeatedly supported paying interest on reserves, but he has warned lawmakers that the move would increase the federal budget deficit. Last week, Mr. Greenspan estimated that paying interest on reserves would cost the Treasury between $300 million and $500 million a year.
The ABA report takes a two-pronged approach. First, the ABA analyzed what would happen if banks expanded their use of sweep accounts to totally eliminate reserves by 2000. This would rob the Fed of what it earns investing reserves in Treasury securities; the earnings are expected to total $690 million this year.
The ABA then looked at what would happen if the Fed paid interest on reserves. The trade group predicted that banks would stop expanding their use of sweep accounts and would maintain about $12 billion in reserves. The Fed would pay about 5.25% in interest, or $630 million in a year-but it would earn 5.75% on Treasury securities, or $690 million a year. This 50 basis-point spread would be maintained if rates moved up or down.
Gil Schwartz, a former Fed lawyer who wrote the reserve requirement rules, said the ABA is underestimating how much the Fed will have to pay to attract bank reserves.
"You have to address this on the merits," said Mr. Schwartz, a partner at the Washington law firm of Schwartz & Ballen. "If the Fed has the need to pay interest on reserves in order to implement monetary policy, Congress should empower them to do so without regard to the budgetary impact."
Mr. Chessen conceded that some of the assumptions could be challenged. "But that is not the issue," he said. "The issue is that reserves have been declining and paying interest helps the Fed manage reserves better."
The program's costs would rise substantially if ABA is wrong about banks eliminating reserves by 2000 or if banks lower their reserve levels even after the Fed started paying interest, Mr. Chessen said.
The trade group excluded reserves kept for check clearing from both estimates. Banks would continue to keep these reserves at the Fed interest- free.