For awhile now, I think since Lehman Bros. went kaput, the Federal Reserve has been paying interest to the member banks on the reserves the banks keep on deposit with the Fed. The reserves that the banks keep on deposit with the Fed is money that the banks borrow from the Fed at an interest rate lower than the interest rate that the Fed pays the banks on their reserves.
When I tell people this, they look at me like I am lying or nutty or just don’t know what I am talking about. I never get a response other than a look.
Well, here is the link to the Federal Reserve Bank of Atlanta explaining the accuracy and truth of my statement above and the rational for paying banks to borrow money and not loan it to you:
“Some Observations Regarding Interest on Reserves”
One of the livelier discussions following Federal Reserve Chairman Ben Bernanke’s testimony to Congress on monetary policy has revolved around the issue of the payment of interest on bank reserves. Here, for what it’s worth, are a few reactions to questions raised by that discussion:
Is interest paid on reserves (IOR) a free lunch?
Ken Houghton has the following objection:
“… in September of 2008, the Fed decides to pay interest on reserves—including Excess Reserves. The banks can now make 25 times what they pay in interest, risk-free, just by holding onto money. The Fed is, essentially, leaving $100 bills on the sidewalk.”
I’m not sure exactly where the “25 times” comes from, but it seems to me that the most obvious transaction would be to borrow in the overnight interbank lending market—the federal funds market—and then “lend” those funds to the Fed by placing them in the Fed’s deposit facility. The differential between the return on those options is a good deal lower than a multiple of 25.
Do you really think the Federal Reserve was created and functions for the benefit of the American public? Will the Fed loan money to you at 0.17% interest and then pay you 0.25% interest to keep that money on deposit at the Fed?
If the rational to pay interest on the reserves sounds complex, convoluted, and ridiculous, it is because it is. The real reason is to take money from you and give it to the member banks.
(Mom, the member banks are the largest banks in the US such as JP Morgan Chase, Goldman Sachs, Citibank, Wells Fargo, Bank of America, The Bank of New York, etc.)