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Tame Inflation Without Subsidizing Banks

When central banks raise interest rates, they also raise the cost of payments on commercial banks’ excess reserves. The best way to avoid a windfall for bankers – and a burden for taxpayers – is to shrink the central bank’s balance sheet by selling government bonds while implementing a temporary increase in minimum reserve requirements.

LONDON – In an effort to tackle inflation woes, major central banks have been raising interest rates aggressively. But a byproduct of the recent rate hikes is higher interest payments on central-bank deposits held by commercial banks – in effect, a transfer of public-sector money to private banks.

The Eurosystem – comprising the eurozone’s 20 national central banks and the European Central Bank – will pay €107 billion ($111 billion) in interest (on €4.3 trillion of deposits) to financial institutions during 2023.That number will increase to €129 billion when the ECB raises its deposit rate to 3% in March, as it has promised to do.

In the United States, the Federal Reserve recently voted to raise the interest rate paid on reserve balances to 4.65%. That means it will owe $140 billion in interest payments on roughly $3 trillion of bank reserves this year. The Bank of England is also on the hook for similarly massive handouts to commercial banks.

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