Will Paying Interest on Reserves Endanger the Fed’s Independence?

Will Paying Interest on Reserves Endanger the Fed’s Independence?

As a consequence of the large-scale asset purchases by the Federal Reserve during its quantitative easing operations that began during the Great Recession in 2008, the Fed’s interest income increased rapidly. The additional income was partly used to pay interest on reserve balances held by the banks at the Fed, while the remaining surplus was used to finance other governmental programs, such as the Consumer Financial Protection Bureau and the U.S. highway system. The remaining surplus funds were then transferred regularly to the U.S. Treasury.By these actions, a new financial link between monetary policy actions and Treasury revenues was established, thereby directly intertwining monetary and fiscal policy. Unless the policies of maintaining a large balance sheet and paying interest on reserves is reversed, increased political pressures may well endanger the independence of the Fed in the formulation of monetary policy and threaten the position of the Fed as a separate and independent government agency.

Robert Heller

Cato Institute

September 2019

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