The Federal Reserve pays interest on reserve balances. It started doing this in October 2008 as part of the reforms after the Great Recession. However, I think this is very problematic. The total reserves as of 8/2/23 are $3.19 trillion. The rate paid is about 5.25%, or about $175 billion per year.
This money actually fuels inflation. When the Fed raises rates, this amount goes up. The banks love it because it is free money - it is effectively a subsidy from the Fed. They don't have to make risky loans to earn it. And the bizarre thing is that the Fed doesn't treat the amount paid as an expense. Instead it is capitalized. The total is called a "deferred asset" because of the fiction that this reduces what the Fed owes the US treasury in the future.. The total as of 8/2/23 is $85 billion. This total is going to keep going up. This is still a very small part (about 1%) of the Fed balance sheet, which is $8.2 trillion. It is "magic money" that just falls out of the sky, that one party sees as free money and the other party doesn't treat as an expense.
Here is an article on the topic: https://www.cato.org/cato-journal/spring/summer-2019/interest-reserves-history-rationale-complications-risks#complications-and-risks One must question the wisdom of making IOER a permanent part of the Fed’s toolkit, given the resulting complications and risks.
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