Last year the Federal Reserve paid about $26 billion in interest on the money banks kept deposited there, up from the zero dollars it paid before the financial crisis a decade ago. For many people, this is a source of distress. The more the Fed pays in interest to banks, the lower its profit, the less it pays into the Treasury, and the more taxpayers have to pick up the slack. It seems like a boondoggle, but the Fed regards its payments as a routine instrument of monetary policy, no more political than steering a supertanker.
The reserves at issue consist of the cash banks keep in vaults, plus electronic money that they stash at the Fed itself. Before the crisis, banks that were short of their minimum level of reserves would have to borrow reserves from other banks at what’s known as the federal funds rate. The Fed can shrink the amount of reserves in the banking system by selling bonds because banks use reserves to buy them. The scarcer the Fed made reserves, the higher the federal funds rate would climb.
