The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff posts another expensive Federal Reserve interest on reserves update.
|From the Fed's 2Q23 Financial Statement|
The Fed has released its second quarter financial statement and the central bank paid out over $44 billion in risk-free, zero maturity interest on reserves to private commercial banks. That’s 487% higher than a year ago ($7.48 billion), over $176 billion on an annualized basis, and a huge contributing expense to the Fed's growing operating losses (subsidized by the Treasury/taxpayer).
With several Fed governors talking about one more rake hike in 2023 we’re looking at an even bigger payout before year end.
Paying higher interest on reserves wouldn’t be a problem if the Fed didn’t hold so many assets, but it has been incredibly slow winding down its balance sheet with commercial banks today still holding $3.23 trillion in reserves versus, well… $3.23 trillion in June of 2022 when the FOMC decided to finally get tough on inflation.
Yes, tough as it got the Fed really hasn’t put a dent in the banking system’s reserve balances.
By contrast in the summer of 2008, before the Fed adopted its new “abundant reserves” floor operating system, the banking system held just $46 billion under its traditional corridor system. If the Fed had been paying banks the same 5.4% interest on reserves rate it pays now under that regime the industry would have collected just $2.48 billion a year in payments, not the $180 billion its on track to receive over the next twelve months.
(Links to IOR policy rates, system reserves, and the Fed's Q2 quarterly statement below)
Monetary economist George Selgin, a longtime critic of the floor operating system and a favorite of the Economics Correspondent, recently argued in a Mercatus Center podcast that…
“If you go back and look at all of the arguments given for switching to a floor system, after the fact, mind you, because when the switch happened during the 2008 crisis… …all kinds of rationales were given for making it permanent, claiming that it would keep banks liquid, that it would make monetary control easier and blah, blah, blah. Every one of those complaints has been shown to be false. The system has not proven easy to operate, and the cost has been immense.”
(reference links from the Economics Correspondent)
Interest on reserves rate
Federal Reserve second quarter financial statement (page 3 for income/loss)