With the exception of a few years in the late 1990s and early 2000s, the U.S. government has run a budget deficit every year for decades. Annual deficits over the past 10 years have run from $438 billion in 2015 to a whopping $1.41 trillion in 2009. That has made it more important than ever for the federal government to take maximum advantage of revenue sources while clamping down on spending wherever possible.
Taxes provide the lion's share of government revenue, but there's one source of money most people don't even know about, yet it still provides revenue windfalls on a regular basis -- including $80 billion in transfers announced earlier this month. This revenue source plays an instrumental role in managing the U.S. economy, and it's interesting how its operations manage to generate some extra spending money for the federal government on the side.
What the Federal Reserve is paying the Treasury this year
The Federal Reserve Board announced on Jan. 10 that it had determined its preliminary results for its 2017 operational year. The central bank's financial statements indicated that it had generated $80.7 billion in net income during the year, and it would pay $80.2 billion of that money back to the U.S. Treasury for general use.
The Fed's income comes almost entirely from the securities that it holds in its efforts to implement monetary policy. In 2017, the Fed brought in $113.6 billion in interest income from securities that it acquired in its open market operations, including both Treasury debt and a combination of debt and mortgage-backed securities issued by government sponsored enterprises like Fannie Mae and Freddie Mac. In addition, daily revaluation of investments denominated in foreign currencies led to currency-related gains of $1.9 billion during the year, and payments for services rendered amounted to another $442 million.
Against that income, the Fed has various amounts that it has to pay. The most significant is the interest that the central bank owes to large banking institutions that hold reserve balances with the Federal Reserve. During 2017, that interest expense amounted to $25.9 billion. The Fed also paid $3.4 billion under repurchase agreements covering various securities.
From the standpoint of running the central bank, the Fed had net operational expenses of $4.1 billion. It also paid $740 million on various expenditures for the Board of Governors, along with $573 million that went toward the Consumer Financial Protection Bureau. Costs of minting, issuing, and retiring currency amounted to $724 million in 2017.
How did the Fed's income compare with past years?
The $80.2 billion figure is significant, but it's also down from recent years. In explaining the roughly $11.7 billion reduction in net income from 2016 levels, the Fed said that higher interest expense on reserve balances held at the central bank was only partially offset by larger interest income on securities obtained in open-market operations. That makes sense because the Fed boosted its short-term interest rates on three separate occasions in 2017, thereby increasing its own financing costs on reserve balances.
From a longer-term perspective, Fed watchers should expect the amount of income that the central bank generates to deteriorate further in the coming years. In October, the Fed started its balance-sheet normalization program, gradually reducing its holdings by decreasing the amount of principal payments it reinvests in replacement securities after maturity. The more than $4.4 trillion in holdings that the central bank reported in its last quarterly report will likely drop back toward the less-than $1 trillion that the Fed routinely held prior to the financial crisis. That, in turn, will likely reduce Fed income back toward the $31.7 billion it generated in 2008.
Don't count on Fed income
What this means is that federal government policymakers shouldn't count on the Fed to pony up $80 billion windfalls each and every year. For now, the income is a useful tool to help reduce the federal budget deficit slightly. Eventually, it will diminish, and the government will have to find other ways to replace what the central bank produced over the past several years.