This is the Cato Daily Podcast for Friday, February 19, 2010, I'm Caleb Brown.

Fed Chairman Ben Bernanke has made hay about the Fed's new tools to control lending

when it comes time for the central bank to

sop up all that liquidity now residing in US banks. But those tools are

almost entirely new and untested. The Fed has already gone far beyond its

traditional role.

So says Cato Institute Director of Financial Regulation Studies, Mark Calabria.

Looking through Chairman Bernanke's prepared remarks, he says this, in October 2008, Congress gave the Federal Reserve statutory authority to pay interest on

banks' holdings of reserve balances.

By increasing the interest rate on reserves, the Federal Reserve will be able to put significant upward pressure on all short-term

interest rates, as banks will not supply short-term funds to the money markets at rates

significantly below what they can earn by holding reserves at the Federal Reserve Banks.

That seems that at some point the Federal Reserve will be competing with an economy that's

heating up in terms of trying to keep these interest payments up against what those interest rates would be competitively.

Is that right?

To some extent, I mean what the Fed is trying to achieve in this is to be able to set a floor

under interest rates and to sort of suck liquidity out of the system by basically paying

banks to peep their money with the Fed.

In theory, this certainly sounds like on something on paper that could work.

I think the problem with it is going to be when theory hits the reality. For starters as you

mentioned they would be competing with the rest of the economy. So let's say

that a bank could lend money at 6% on a mortgage.

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