Fed Paid Funds, Banks More Than $90 Billion Over Past Year for Sitting on Clients’ Cash

U.S. Federal Reserve Board Chairman Jerome Powell departs from a meeting with the Treasury Department's Financial Stability Oversight Council at the U.S. Treasury Department in Washington, D.C., on Oct. 3, 2022. (Anna Moneymaker/Getty Images)

The Federal Reserve’s anti-inflation efforts are becoming increasingly expensive. The U.S. central bank has paid out more than $90 billion to banks and money market funds over the past year for letting the cash of their clients lay dormant. The payouts have ballooned in recent months as the Fed has repeatedly hiked interest rates.

The Fed’s policymakers boosted rates from virtually zero in mid-March 2022 to more than 4 percent—the highest in more than 25 years—in a bid to curb inflation that has increased over the past year to a 40-year high of some 9 percent.

The Fed pays interest on client deposits that banks electronically park at the central bank in order to discourage them from extending loans at cheaper rates. When interest rates are high, banks would prefer to store more money at the Fed, reducing credit supply.

The interest now stands at 4.4 percent annually. By comparison, the interest on a standard mortgage just one year ago was just 3.45 percent.

The Fed has been authorized by Congress to pay the interest and has done so since 2008.

In addition, some institutions are allowed to buy Treasury securities from the Fed and sell them back a day later at a slightly higher price—so-called reverse repos. The price difference adds up to a 4.3 percent annual return. While that’s lower than the interest on deposits, it provides immediate cash flow since the profit accrues every day. Moreover, reverse repos are open not just to banks, but also to money market funds.

At the current rates, the interest on deposits and reverse repos adds up to nearly $4 billion a week. Over the past 12 months, the payouts added up to more than $92 billion, estimated from the weekly averages of reserve balances at the Fed and daily reverse repo volumes.

The Fed can’t technically run out of money because it can create dollars electronically. Every dollar it creates, however, adds to inflationary pressures in the real economy or the financial markets, depending on where the money eventually ends up being spent.

Inflation has been running hot since the economy was inundated with trillions of dollars in extra government spending during the COVID-19 pandemic.

The Fed has been trying to tighten the money supply and curb demand through higher rates in order to ease inflation, which dropped to some 6.5 percent in December 2022 from 9 percent in June 2022. Forecasters expect the Fed to push the rates a bit higher yet, perhaps above 5 percent, before easing off.

Many economists expect a recession this year or next, surmising the Fed has increased the rates too aggressively to achieve a “soft landing.”

Inflation taming has been made more difficult by the continued spending spree by the federal government, which was recently furnished by Congress with a $1.7 trillion omnibus spending bill.

The government debt has grown so much that the interest on it is slated to rival the entire military budget.