eli5 Where does all the extra money from fed interest rate hikes go?

Question

Especially regarding mortgage rates- folks are paying huge increases in monthly payments.
I’m assuming “to the government” but does it just get held somewhere?

In: 67

Answer 1

Lot of complicated answers here for a simple question…

tl;dr: The interest is collected by the Fed from banks loaning out mortgages (and by extension, the homeowners). Most of the interest is written off and thus removed from the economy to help counteract inflation.

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The Federal Benchmark Interest Rates are the interest rates used when the US Federal Reserve loans money to banks, usually to back mortgages. The banks are who pay this interest. (Banks can and do pass that and more to the customer but that doesn’t affect this question.)

So the US Federal Reserve loans out all this money and collects a set percentage of it as interest. Some of that interest is used to supplement additional loans and some is used to pay for the operating expenses of the US Federal Reserve. The remaining 95% (made up number) is simply written off.

The Federal Benchmark Interest Rates don’t exist to make money for the US Federal Reserve. They exist to remove money from the economy as a method to limit or reduce inflation.

Economists will tell you that having a moderate amount of inflation is a good thing and they have a pretty solid argument. If you have reverse inflation (or deflation), the value of money held in saving increases over time which disincentivizes spending (“Why spend it now if it’ll be worth more tomorrow.”) Free-wheeling inflation causes the price and goods to outstrip the increase of pay. In both cases, you end up with fewer people spending money which is bad for the economy.

The Federal Reserve exists primarily as a means to control inflation. Congress appropriates a shit ton of money for some reason or another (stimulus checks, for example) which drastically increases inflation. So the Federal Reserve increases the benchmark interest rates to remove this money to slow inflation. They just didn’t do it quick enough in this case and now a McDonald’s meal for 2 can exceed $20.