Power & Market

Powell Raises Rates, Is Wrong About the Fed Not Subsidizing Wall Street

Powell Raises Rates, Is Wrong About the Fed Not Subsidizing Wall Street

The Federal Reserve continues to slowly increase the federal funds rate from 1.5 to 1.75 percent today, the first such decision of the Jerome  Powell era. More interesting is that, when asked during his press conference, Chairman Powell dismissed the idea of the Fed's Interest on Excess Reserves (IOER) policy as a subsidy to Wall Street. 

IOER is the Fed's payments on interest held by large banks at the Fed beyond what they are required to store. Though the policy is a new one - coming into practice in 2008 - it has quickly become, in the words of former Chairwoman Yellen, the key policy tool of the Fed. The idea is that the Fed can set the lower bound for interest rates with the tool (as a risk free way to park reserves), while still giving the Fed the flexibility to expand its balance sheets. In doing so, as George Selgin has done a great job writing about, the Fed has transitioned from a traditional "corridor"-style operating system (focused on overnight bank lending) to a "floor" system. 

Putting aside for this post questions about the policy's effectiveness and legality, this policy is one of the most vivid examples of how the Federal Reserve benefits Wall Street at the expense of tax payers. After all, the money the Fed uses to make these payments on interest comes from the profits of the Fed itself. As such, Wall Street banks have now been given a risk-free avenue to get return on their holdings. Clearly the banks see this as a better return than they would get lending on the market, or else we wouldn't see excess reserves continue to stand at over $2 trillion. 

As this policy comes under increased scrutiny on Capitol Hill, expect to see the topic continue to come up in the future. 

Other highlights from today announcement include the Fed acknowledging that economic growth has slowed so far in 2018, with the language used to describe economic and job browth being changed from "solid" to "moderate." Still, the FOMC increased their projections for economic grwoth - from 2.5% to 2.7% - though Powell noted in his press conference that there is some concern over the impact of President Trump's tariffs going forward.

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