Elon Musk and Vivek Ramaswamy are right to spotlight excessive spending at the Federal Reserve, but their focus on the $5 billion annual cost of the system’s 24,500 employees misses the principal opportunity for savings. The approximately $180 billion in interest on reserves the Fed pays annual offers a far greater potential cost reduction. Unlike the Treasury with its interest payments on the national debt, the Fed is under no contractual obligation to pay interest on reserves and could reduce these payments unilaterally and eliminate them with Congressional authorization.
The Fed’s payment of interest on reserves is a relatively recent phenomenon. For nearly a century following its creation in 1913, the Fed paid no interest on reserves, instead requiring banks to hold a percentage of their deposits at the central bank without compensation. This 95-year-old regime ended in October 2008 with the passage of the Emergency Economic Stabilization Act, which allowed the Fed to begin paying interest on reserves.
Initially, these payments were intended to absorb excess liquidity created by quantitative easing and thereby mitigate the inflationary effects of the Fed’s rapid balance sheet expansion. The costs were modest at first. From late 2008 to 2016, the interest rate on reserves was 0.25%, and annual payments averaged just $5 billion—a negligible expense compared to the record profits the Fed was generating during that time. However, the situation has drastically changed.
Today, the interest rate the Fed pays on reserves has skyrocketed, driving up costs and pushing the Fed into massive annual losses. In 2023, the Fed spent $177 billion on interest payments while posting a $114 billion loss—the largest in its history. The Fed is projected to lose another $80 billion this year followed by additional losses in 2025.
Ensuring that the banking system holds adequate reserves at the Fed is a core function of America’s central bank. But, rewarding banks for not lending to consumers and businesses was an extraordinary policy adopted during the global financial crisis. Absent an emergency, subsidizing banks to hold excess cash instead of using those funds to lend to consumers and businesses is unnecessary and fiscally irresponsible.
Predictably, banks will resist any policy changes that would reduce or eliminate this windfall. In 2020, the Bank Policy Institute, chaired by JPMorgan Chase CEO Jamie Dimon, published a white paper arguing that the Fed lacks the statutory authority to require reserves under the current monetary policy framework. The paper also asserted that the Fed cannot consider its losses when determining reserve requirements.
Yet the Fed has ample authority under existing law to reinstate required reserve balances that would not be entitled to interest payments. By raising required reserve balances to 3% of most demand deposits and up to 14% on deposits over $25 million, the Fed could eliminate the interest it pays on these required reserves and remind banks of its regulatory power.
Returning the Fed to profitability will require Congress to act. Legislation is needed to increase reserve requirement balances beyond their current limits and remove the Fed’s ability to pay interest on reserves absent an emergency. Restoring the Fed to profitability would not only make the Fed more financially stable, but also improve the federal government’s fiscal position more broadly. Returning the Fed to profitability would enable the Fed to resume its annual profit transfers to the Treasury, and these transfers can be substantial. Between 2011 and 2021, they totaled $920 billion, with $59 billion transferred in 2022 alone.
Moreover, eliminating the Fed’s interest payments to banks would bring an end to an unnecessary form of government expenditure. While the Fed’s interest payments are technically outside the federal budget, they represent a substantial transfer of public funds to private enterprise. Curtailing this practice would eliminate approximately $180 billion dollars of hidden federal spending.
Most Americans are unaware of the Fed’s massive annual payments to banks. The status quo, which allows the Fed to voluntarily lose hundreds of billions of dollars while enriching the financial sector at taxpayer expense, raises serious questions about whom our financial system is intended to serve. At a time when Americans are increasingly frustrated by economic inequality and government overreach, ending the practice of paying interest on reserves would better align the Fed with the interest of the American people.
Musk and Ramaswamy are right to call attention to the Fed’s spending. But to truly make an impact, the focus must shift to the far greater sums tied up in interest payments on reserves—a reform that could save taxpayers hundreds of billions of dollars.
