A new focus on the need to cut federal government spending is a welcome development — especially if it leads to a complete financial and performance audit on the functions carried out by government agencies. One agency that has long escaped such scrutiny, though, is the Federal Reserve, our nation’s central bank, on the pretext that too much oversight might compromise its independence.

Such daintiness deserves to be dropped in light of the fact that the Fed has become quite the big spender of late. Since March 2022, when its monetary policy-making committee first began moving interest rates up to its current target range of between 5.25 percent and 5.50 percent from near zero, the Fed has paid out more than a half trillion dollars in interest on cash accounts held by commercial banks and money market mutual funds.

Why does the Fed provide such generous compensation to privately-owned financial enterprises to keep their money sitting idle? Fed policymakers will explain that doing so is their primary tool for reducing inflation. By paying interest on the funds that banks hold in their reserve balance accounts, the Fed offers banks a risk-free option that sets a high bar against which private sector borrowers must compete.

The fewer loans made to customers, the less economic activity; by the Fed’s reckoning, that lowers inflation. Money market mutual funds are similarly compensated when they park cash at the Fed through what are called overnight reverse repurchase agreements. All of the 11 interest rate hikes carried out by the Fed in the name of fighting inflation during the Biden administration have been implemented by raising these two “administered” rates.

The idea is to prevent trillions in excess liquidity from entering the real economy. Yet how did financial institutions acquire such enormous amounts of cash?  The very funds that the Federal Reserve keeps corralled by paying high interest rates were actually created by the Fed — literally with a keystroke — by purchasing $4.5 trillion in Treasury debt and mortgage-backed securities between March 2020 and March 2022.

The intended objective was to stimulate economic activity by supporting the flow of credit to households and businesses. Yet it seems that banks were able to recognize a sweet deal when they saw it. When the Fed officially ended its purchases and started raising rates in March 2022, commercial banks were hardly inclined to devote all those newly acquired reserves to serving the needs of borrowers.

According to statistics provided by the Federal Reserve Bank of St. Louis, the level of reserve balances maintained by commercial banks on deposit at the Fed is about $3.3 trillion — just as it was in April 2022. So how should the Fed be evaluated in terms of a financial and performance audit? Functionally, it makes dubious sense to entice financial institutions away from making private sector loans by paying high rates of interest on Fed depository accounts.

The rapid increase in non-bank lending through private credit firms may be an unintended consequence of the practice, posing new regulatory risks. Meanwhile, those payments continue to be costly.   

Should taxpayers be providing subsidies to commercial banks and money market mutual funds? The Fed is required by statute to remit back to Treasury the bulk of its interest earnings from its own portfolio.

Mark, though, that these were more than wiped out by the Fed’s interest expenses. Such interest totaled $102.4 billion in 2022, $281.1 billion in 2023, and $121.6 billion just through June 2024, with the Fed having to conjure up an additional $179 billion by borrowing against future remittances to the Treasury. Yet journalists have yet to press the Fed’s chairman, Jerome Powell, on the matter of fiscal transfers to the financial industry.

What’s the matter with asking about the public costs — nevermind ethics — of this practice? Are reporters going to let the question, unanswered, go to, say, the Musk Commission on government efficiency that President Trump suggests he’ll establish should he be elected president? If so, why not have it inquire just how much interest from the Fed has gone to the five largest American banks: JPMorgan Chase, Bank of America, Wells Fargo Bank, Citibank, and U.S. Bank?

Or how much in interest payments has been paid to foreign banks that hold accounts at the Fed? It’s not as if paying administered rates is the Fed’s only tool for conducting monetary policy. No less a chairman than Paul Volcker fought inflation by selling off Fed holdings of Treasury securities, tightening the money supply by raising the interest rate at which banks borrow funds from each other. A recession followed, but then the Great Reagan Boom.

Paying interest on bank reserves became the Fed’s go-to method in much more recent years, as part of the emergency powers granted to the Fed in October 2008. Fed officials have embraced this tool as a less messy way to raise interest rates than open market operations — especially during this latest battle with inflation. Given that the Fed has been running an operating loss since September 2022, though, it’s time to consider its efficacy. 

Expect the Fed to guard its independence zealously by resisting any advice, or even inquiries on its operations, from Congress, or a Musk commission, or the journalists. Yet there is irony in the Federal Reserve’s longstanding claim that its independence is partially derived from being able to cover its own expenses. As the American public has a right to point out: Not any more.

Ms. Shelton’s new book, ‘Good as Gold: How to Unleash the Power of Sound Money,’ will be published on October 8.