As the Fed unleashed its unprecedented monetary measures – quantitative easing, ZIRP, Operation Twist, and the rest – many wondered what unintended consequences would follow. Fears of a crashing dollar, runaway inflation, and a loss of credibility proved unfounded. The Fed now says it’s mostly accomplished its goals, and it’s time to “normalize” rates.
The trip may have seemed like a free ride, but there’s bad news: it wasn’t, and won’t be. The return to normal rates will be very expensive, and borne by American taxpayers.
As The Fed Raises Interest Rates – Who Wins?
The world’s largest banks do, including many foreign institutions, like Deutsche Bank and the People’s Bank of China. At what cost? Well, maybe $50 billion or so, St. Louis Fed president James Bullard has surmised, enough to double the largest banks’ annual profits. But that now looks like an underestimate.
Shocking as all this may sound, it’s already been happening under a program called “interest on excess reserves”, a power the Fed’s picked up in 2008. “Excess reserves” are amounts that banks park safely at the Fed while looking for better ways to spend them. Back then, it was no big deal, for the amounts were tiny (less than $2 billion in 2007). But today, after all the quantitative easing, zero interest rate policies, and related magic, those same excess reserves add up to (are you ready?) 2.4 trillion dollars. So that’s the amount US on which taxpayers are now, effectively, paying interest, since what the Fed doesn’t pay out comes back to the US Treasury.
At the moment, the interest rate paid on those amounts is quite low—just .25%, so that the interest bill is “just” $10 billion or so. But here’s the rub: if the Fed is to successfully raise rates in the overall economy, it must increase the rate it pays on excess reserves first, and keep raising it in tandem with the Fed’s more general goals over time. The Fed acknowledges this on its website