The Federal Reserve should stop paying interest on reserves

In the aftermath of the financial crisis of 2008 the Federal Reserve took many extraordinary measures to prop up the financial system.  Among these was the decision to pay interest on funds held in reserve at the Fed by member banks as authorized by the Emergency Economic Stabilization Act of 2008.

This policy may have been prudent at the height of the crisis, but now, more than ten years later, the banks have returned to stability and this support is no longer needed.

In the almost one hundred years before the 2008 crisis the Fed has only paid interest on reserves very recently for only two short months, first after the 9/11 attacks and second at the beginning of the crisis in 2007.  Despite two world wars, a Great Depression, periods of strong growth, and other gyrations of the economy and financial system no justification was found for paying such interest during these historic events.

Banks have been clamoring for interest on reserves since the beginning of the Fed.  But, there are no good reasons to pay interest on reserves outside of crisis periods.  Reserves held at the Fed and elsewhere are created by the Fed itself as so called “high-powered” money, and in a sense belongs to the Fed. 

Early in the crisis the interest rate paid on reserves was only 0.25%, but now the rate has risen to 2.35% [1].  In June 2019 the total reserves held at the Fed totaled $1577B [2].  At straight interest that equates to $37B in interest paid for the year.  This is an enormous amount of money that the banks have done nothing to earn.

The interest paid is not just a Fed accounting mechanism.  Rather, these are real funds that would otherwise have been deposited with the US Treasury and been available for Congress to spend.  These funds are paid on a kind of autopilot mode without annual Congressional appropriations authorization. So, they have and will continue to grow without any Congressional appropriation or additional authorization.  

If the banks still need this money, then there is something fundamentally wrong with the banks that needs to be resolved.  But, it the banks have recovered, as is evidenced by their strong profitability, then they no longer have need of these funds and Congress should rescind the payment of interest on reserves.

[1] https://www.federalreserve.gov/monetarypolicy/reqresbalances.htm

[2] https://www.federalreserve.gov/releases/h3/current/