Senate Banking Committee Chairman Alfonse M. D'Amato called for legislation Wednesday to let the central bank pay interest on reserve balances.
It is the banks' money, the New York Republican said, "and we should let them earn interest on it. I would ask some of my colleagues to consider joining in a legislative effort to do just that."
Sen. D'Amato said he is concerned that dwindling reserve balances-down 34% in a year, to $11.7 billion in January-would impede the Federal Reserve's conduct of monetary policy.
Fed Chairman Alan Greenspan, who was on Capitol Hill to present his semiannual report on the economy, said the central bank has always supported paying interest on reserves. "The problem is that would induce a fairly significant reduction in federal budget receipts," he cautioned.
Mr. Greenspan's comments came amid a discussion focused heavily on the economy. The central bank, he said, is on "heightened alert" for signs of inflation.
"We cannot rule out a situation in which a preemptive policy tightening may become appropriate before any sign of actual higher inflation becomes evident," he said.
The markets reacted to this threat of higher interest rates by pushing up the yield on the 30-year Treasury bond to 6.75% by midday, prompting a substantial selloff in bank stocks. Money-center banks were hit hardest; the S&P bank index fell 1.83% by 1 p.m. and ended the day down 1.46%, at 529.65. The Dow Jones industrial average fell 0.78%, to 6,983.18.
Shares of Citicorp fell $2.125, to $121.625; Chase Manhattan Corp. dropped $2.25, to $103.50; and Wells Fargo & Co. lost $2.25, to $313.75.
Bank economists are predicting a rate hike in the third quarter.
"He is setting the stage for an adjustment later in the year," said Anthony Chan, chief economist for Banc One …