I am confused about how this works. I presume the Fed is just paying them the above-market interest rate, crossing their fingers, and hoping that they receive as much money as possible? And they’ll have to continue paying the banks this above-market rate for essentially eternity in order to ensure that the money stays put in the Fed’s vaults?
And how is this effective? I know income inequality has been increasing due to the uneven distribution of money (because of how government entities and large corporations receive the newly-generated money before everyone else)…if this is the case, then I presume this policy of setting an above-market interest rate to destroy money is not 100% effective?
But the banks are still getting paid money from the Fed…isn’t that money going to circulate into the economy? So how is this helping anything?
The story assumes that banks will lend their excess reserves when market interest rates rise. To prevent the excess reserves from getting into the hands of people, the Fed will have to raise the interest rate it pays on reserves. But this is not the normal way that banks operate. When banks have excess reserves, they normally convert them into required reserves by issuing fiduciary media by creating credit. To prevent this process, the Fed must create a spread between the interest rate it pays on required reserves and the interest rate it pays on excess reserves.
Excess reserves are around $2.5 trillion and the interest on them, according to the story is $12 billion. The interest payments to banks, then, are a drop in the bucket in a $18 trillion GDP. But, the excess reserves are much more than a drop in the bucket and the fiduciary media that could be created on the excess reserves are more than the bucket.