The Federal Reserve has not yet determined whether it would beable to legally implement negative interest rates in the U.S.,Chair Janet Yellen said.

“I would say that remains a question that we still would need toinvestigate more thoroughly,” Yellen said Wednesday in response toquestions from the House Financial Services Committee inWashington. “I am not aware of anything that would prevent us fromdoing it, but I'm saying we have not fully investigated the legalissues — that still needs to be done.”

A 2010 staff memo posted on the central bank's website late lastmonth cast doubt on whether the law that authorized the Fed to payinterest on excess reserves, or IOER, also would grant it theauthority to charge interest.

That could constrain the policy-setting Federal Open MarketCommittee's ability to take interest rates below zero in thefuture, a scenario that has gained increasing traction in financialmarkets over the past few weeks as mounting concerns over economicgrowth have raised questions about the tools available to centralbanks for battling the next downturn.

The Bank of Japan and the European Central Bank recently cuttheir benchmark rates into negative territory in an attempt toprovide more stimulus.

“I do not expect that the FOMC is going to be soon in thesituation where it's necessary to cut rates,” Yellen said duringher testimony. The possibility of negative rates is “somethingthat, in light of European experience, we will look at, we shouldlook at — not because we think there is any reason to use it, butto know what could potentially be available.”

The probability of negative rates on U.S. dollar borrowings bythe end of next year implied by trading in options on eurodollarfutures contracts has risen to 17 percent from 6 percent a monthago, according to data compiled by Bloomberg. In its annual stresstest for 2016, the Fed is asking banks to assess their resiliencein scenarios that include negative yields on short-term U.S.Treasury securities.

The Financial Services Regulatory Relief Act of 2006 granted theFed the ability to pay banks interest on reserve balances depositedat the central bank. The IOER rate has been instrumental in theFed's effort to lift rates, which it did in December for the firsttime since 2006.

According to the act, “balances maintained at a Federal Reservebank by or on behalf of a depository institution may receiveearnings to be paid by the Federal Reserve bank at least once eachcalendar quarter, at a rate or rates not to exceed the generallevel of short-term interest rates.”

The authors of the 2010 memo suggested “several potentiallylegal and practical constraints” to implementing negative IOER,adding that it was “not at all clear” that the law would permitcharging interest on reserve balances.

“It isn't just a question of legal authority,” Yellen saidWednesday. “It's also a question of, could the plumbing of thepayment system in the United States handle it? Is our institutionalstructure of our money markets compatible with it? We've notdetermined that.”

Bloomberg News

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