How The Fed Has Exacerbated Inequality

One of the confusing concepts in public economics is how the government prints money and where it goes.  The Treasury is responsible for literally running the presses that print the cash, but the Fed is in charge of deciding how much money should be created and determining where it goes.  This is a bit odd because the Fed is officially a private bank that is independent from the government.  Why would we want an independent private bank to get the profits from printing money?  The Fed’s independent control over the money supply is supposed to be one way the government is prevented from printing money to pay for government spending.  But the Fed deliberately increases the money supply every year, so why shouldn’t the government get the profits of printing money to help pay for spending rather than an independent private bank?

Well, the government ultimately does get the money in a roundabout way.  Printing money is very profitable and the Fed uses these profits to pay for its own operating expenses.  Any money left over after the Fed pays itself is turned over to the US Treasury and this is still a lot of money.  So printing money does subsidize government spending even though the government does not get to budget how much new money it wants to get in any given year.   That depends on the whims of the Fed.  Unfortunately, the Fed is dominated by banking interests.  There is considerable amount of regulatory capture built into the Fed system because the Fed’s true primary mandate is not to keep unemployment and inflation low which is what the economics textbooks say.  The Fed’s main mission is to keep banking system profits high enough to prevent the banking system from going bankrupt.

When the banking system’s profits turned negative in 2007-8, the Fed did everything in its power to help the banks return to profits.  One way the Fed accomplished this was by lending huge amounts of money to the banks at a negative interest rate.  In other words, the Fed has been paying the banks to borrow money from the Fed for the first time in history! So instead of printing money and paying the profits to the government, the Fed has been printing money and directly paying the banks for the past five years.  This welfare payment to the banks has made them quite profitable during this time.  Meanwhile the government has been slashing its spending and raising taxes and Piketty and Saez have found that during the recovery from the great recession, almost all the income growth has gone to the top 1% richest Americans, many of whom are indirectly getting welfare from the Fed via their work with the banks.

The Fed paid the banks over $4billion in 2012 in its ongoing bailout payments.  This is only one way that the Fed helps the banks and it is very small potatoes relative to the record-setting total profits that the big banks are earning, but they have had a particularly pernicious effect on the money supply, causing it to contract at a time when the economy needs a monetary expansion to help fight unemployment by increasing economic growth.  Eliminating the interest payments on bank reserves is a social justice issue.  It would help redistribute Fed largesse from the banksters to the unemployed by decreasing hoarding.  The vast majority of the Fed’s money used in quantitative easing is being hoarded in the banks as excess reserves due to this Fed policy to pay the banks free money to keep it hoarded in the Fed vaults.  No wonder quantitative easing has failed.  It is just being hoarded.  It is almost as if the Fed economists don’t really understand how monetary policy affects recessions.  Or else they do, but they don’t care because the Fed has other priorities.