Commentary

Why the Fed is paying Wall Street banks billions of dollars

(WASHINGTON POST)  December 21, 2015 — It makes a lot of sense.

Did you know that the Federal Reserve is paying banks billions of dollars not to lend money out?

Well, it is. But it is not actually a scandal. It is just how the Fed is trying to keep inflation in check now that it has printed so much money. Not that that should keep some politicians from trying to score whatever political points they can over this. Indeed, Senator Ted Cruz, the Republican presidential candidate, might already be.

Before we get to that, though, let’s talk about what exactly the Fed is doing. The short answer is that it’s raising rates. But the slightly longer one is that it’s raising rates in a different way than it has before. Why? Well, when we talk about the Fed increasing interest rates, we’re really talking about it increasing the interest rate that banks charge each other to borrow money from each other—money stored at the Fed as reserves. And the interest rate they charge depends on how many reserves they have. Think about it like this. The fewer reserves there are, the more valuable they become, and the more banks will ask for in return for them. So when the Fed has raised rates in the past, it’s done so by selling bank short-term bonds that they have had to pay for out of their reserves, draining the financial system of them.

Source: Why the Fed is paying Wall Street banks billions of dollars – The Washington Post