    [Senate Hearing 119-329]
    [From the U.S. Government Publishing Office]

                                                           S. Hrg. 119-329

                      THE FED'S BIG BANK WELFARE PROGRAM:
                      OVERSIGHT OF THE FED'S IORB REGIME
    =======================================================================

                                    HEARING

                                   BEFORE THE

                                  COMMITTEE ON
                             HOMELAND SECURITY AND
                              GOVERNMENTAL AFFAIRS
                              UNITED STATES SENATE

                        ONE HUNDRED NINETEENTH CONGRESS

                                 FIRST SESSION

                                   __________

                               DECEMBER 11, 2025

                                   __________

            Available via the World Wide Web: http://www.govinfo.gov

                           Printed for the use of the
            Committee on Homeland Security and Governmental Affairs

    [GRAPHIC NOT AVAILABLE IN TIFF FORMAT]

    �                               __________

    �                  U.S. GOVERNMENT PUBLISHING OFFICE
    63-069 PDF                  WASHINGTON : 2026
    =====================================================================�

            COMMITTEE ON HOMELAND SECURITY AND GOVERNMENTAL AFFAIRS

                         RAND PAUL, Kentucky, Chairman
    RON JOHNSON, Wisconsin               GARY C. PETERS, Michigan
    JAMES LANKFORD, Oklahoma             MAGGIE WOOD HASSAN, New Hampshire
    RICK SCOTT, Florida                  RICHARD BLUMENTHAL, Connecticut
    JOSH HAWLEY, Missouri                JOHN FETTERMAN, Pennsylvania
    BERNIE MORENO, Ohio                  ANDY KIM, New Jersey
    JONI ERNST, Iowa                     RUBEN GALLEGO, Arizona
    ASHLEY MOODY, Florida                ELISSA SLOTKIN, Michigan

                    William E. Henderson III, Staff Director
         Christina N. Salazar, Deputy Staff Director and Chief Counsel
                   Brett J. Abbott, Professional Staff Member
                   David M. Weinberg, Minority Staff Director
         Christopher J. Mulkins, Minority Director of Homeland Security
                     Alan S. Kahn, Minority General Counsel
                         Laura W. Kilbride, Chief Clerk
                       Ashley A. Gonzalez, Records Clerk

                                C O N T E N T S

                                     ------
    Opening statements:
                                                                       Page
        Senator Paul.................................................     1
        Senator Peters...............................................     3
        Senator Johnson..............................................    11
        Senator Lankford.............................................    15
        Senator Scott................................................    17
    Prepared statements:
        Senator Peters...............................................    35

                                   WITNESSES
                          THURSDAY, DECEMBER 11, 2025

    Norbert J. Michel, Ph.D., Vice President and Director, Center for
      Monetary and Financial Alternatives, Cato Institute............     5
    Ryan Young, Senior Economist, Competitive Enterprise Institute...     7
    Brian S. Wesbury, Chief Economist, First Trust Advisors L.P......     8
    Donald Kohn, Ph.D., Robert V. Roosa Chair in International
      Economics and Senior Fellow, Economic Studies, Brookings
      Institution....................................................    10

                         ALPHABETICAL LIST OF WITNESSES

    Kohn, Donald Ph.D.:
        Testimony....................................................    10
        Prepared statement...........................................    55
    Michel, Norbert J. Ph.D:
        Testimony....................................................     5
        Prepared statement...........................................    37
    Wesbury, Brian S.:
        Testimony....................................................     8
        Prepared statement...........................................    49
    Young, Ryan:
        Testimony....................................................     7
        Prepared statement...........................................    46

                                    APPENDIX

    Majority Committee Report........................................    61
    Senator Scott's chart............................................    79

                      THE FED'S BIG BANK WELFARE PROGRAM:
                       OVERSIGHT OF THE FED'S IORB REGIME

                                  ----------

                          THURSDAY, DECEMBER 11, 2025

                                         U.S. Senate,
                               Committee on Homeland Security
                                      and Governmental Affairs,
                                                        Washington, DC.
        The Committee met, pursuant to notice, at 10:01 a.m., in
    room SD-342, Dirksen Senate Office Building, Hon. Rand Paul,
    presiding.
        Present: Senators Paul [presiding], Johnson, Lankford,
    Scott, Hawley, Moody, Peters, Hassan, Blumenthal, and
    Fetterman.

                   OPENING STATEMENT OF SENATOR PAUL

        Chairman Paul. The Federal Reserve Board (FRB) is one of
    the most powerful, secretive, and unaccountable institutions in
    U.S. history. Its insulation from oversight combined with
    massive coffers and strong statutory authorities makes it a
    uniquely troubling institution.
        To give you an idea of just how powerful the Fed is, in
    2018, Forbes ranked Jerome Powell, the Chairman of the Federal
    Reserve Board as the 11th most powerful person in the world,
    ahead of the prime ministers of England and France. But earnest
    oversight there, I think is long overdue.
        Current law prohibits the Government Accountability Office
    (GAO) from auditing the Fed's vast monetary policy functions.
    The Fed's Inspector General (IG) serves at the pleasure of the
    Fed Board of Governors, the very institution it's supposed to
    hold accountable. This summer, I began investigating the Fed,
    and after months of stonewalling, the Fed finally produced
    information on one of the most significant tools of monetary
    policy, interest rates on reserve balances (IORB).
        The interest on the reserve balances system began after the
    2008 financial crisis, when the Fed aggressively purchased
    assets to flood the market with liquidity. This marked the
    beginning of a transition from the scarce resource reserves
    regime to an abundant reserves regime. The Fed vastly
    underestimated how the transition would play out.
        Initial estimates put the cost of the transition at about
    35 billion. As of May, 2022, these estimates increased to 2.3
    trillion. Under this new regime of abundant reserves, banks
    would receive interest payments known as interest on reserve
    balances on deposits held at the accounts in the Fed. When
    interest rates are low and the Fed's balance sheet is small,
    this is a manageable regime.
        Unfortunately, since 2008 both the size of the balance
    sheet and interest rates have increased the cost of this regime
    to unsustainable levels. Take the size of the Fed's balance
    sheet, before 2008, it was approximately five percent of gross
    domestic product (GDP). After the great financial crisis, it
    rose steadily reaching approximately 18 percent of GDP. During
    the Coronavirus Disease 2019 (COVID-19) pandemic, it soared to
    a record 35 percent of GDP in 2022.
        It's since fallen to approximately 21 percent today, but
    remains well above historic levels. When interest rates were
    near zero from 2010 to 2016, the Fed to pay little in the form
    of interest on reserve balances. But when inflation concerns
    required the Fed to raise interest rates from 2016 to 2019 and
    again from 2022 to 2023, the interest on reserve balance rate
    was a primary tool to do so, requiring the Fed to increase the
    amounts it was paying the banks to get them to hold money at
    the Fed.
        This led to distortions in the Federal funds markets,
    including periods where short term treasury yields were
    actually below the interest on reserve balance rates. When this
    happens, the Fed loses money and taxpayers underwrite the
    losses.
        It's somewhat of a crazy notion to even imagine an
    organization that actually has the ability to print and create
    currency losing money. But the Fed has been losing money for
    the last couple of years. The Fed is supposed to send its
    profits to the Treasury. The interest on reserve balance
    system, though, however, has led to two years of operating
    losses where instead of the money going back to the treasury,
    the money's going to large banks in New York and large banks
    overseas.
        The Fed is taking the Federal funds rate and most of this
    ends up in the largest banks in the world, both foreign and
    domestic. It's a double whammy for the taxpayers. Banks use
    your money that's sitting in a checking account to earn up to
    5.4 percent interest from the Fed, the payment of which is
    underwritten by your tax dollars. Then you pay on average of
    0.0 percent interest on your checking accounts, and they pocket
    the difference.
        It's great for banks. Interest on reserve balance enables
    the Fed without any form of oversight or elections to
    unilaterally transfer wealth from the American taxpayer to the
    biggest banks on Wall Street. Interest on reserve balances have
    totaled hundreds of billions of dollars. Most people even don't
    know they exist.
        Since 2013, the Fed has paid $607 billion to both foreign
    and domestic banking institutions. In 2024 loan, the payments
    amounted to $186 billion. This is essentially 10 percent of our
    deficit, so our deficit could have been reduced it by 10
    percent of that money. We are going back to the treasury
    instead of going to private banks.
        The secrecy surrounding the amounts of these payments have
    allowed unelected officials at the Fed to influence the
    American economy in ways that rival the power of elected
    Members of Congress. For the first time ever, the report I
    released this week revealed the true nature of these payments.
        The data obtained from the Fed shows that the largest banks
    in the country made a windfall. Big names like JP Morgan Chase,
    Bank of America (BoA) City, Wells Fargo, and U.S. Bank raked in
    tens of billions of dollars from holding their money at the Fed
    and essentially not loaning it to the public.
        From 2013 to 2024, interest on reserve balance payments to
    the top five banks amounted to 136 billion, which equals 12
    percent of their profits. Over 10 percent of the profit of the
    banks is basically being paid at no risk to these banks. They
    are not going out and loaning money. They are not having to
    judge risks of loaning it. They just park it at the Fed and are
    able to gather 10 percent of profit with no risk.
        Money was not just flowing to Wall Street though, foreign
    banks also cashed in. 11 of the top 20 recipients of interest
    on reserve balances from 2013 to the present were foreign
    banks. It's kind of hard to fathom that we are using this
    quasi-governmental bank, the Federal Reserve to facilitate
    payments to foreign banks.
        These funds are not exclusive to allied nations. Chinese
    banks alone received about 10 billion in interest on reserve
    balance payments. Oversight of the Fed's interest on reserve
    balance payments is the first step in finally auditing the Fed.
    But there's still much more work to be done.
        My bill and the Fed's big bank bailout, would end the
    forcible transfer of wealth from average Americans to Wall
    Street institutions under the guise of interest on reserve
    balance payments. While my Federal Reserve Transparency Act,
    Audit the Fed, would also allow meaningful oversight of all
    functions of the Fed, which is long overdue.
        If the Fed handed over this data, what is it hiding? What
    is the information they are still refusing to release? It was
    like pulling teeth to get the information we finally got from
    them. But I think it's high time that we do audit the Fed.
    Senator Peters.

                 OPENING STATEMENT OF SENATOR PETERS\1\

        Senator Peters. Thank you, Chair Paul, and thank you for
    each of our witnesses for being here before the Committee
    today. The Federal Reserve plays a critical role in
    implementing sound monetary policy to strengthen markets as
    well as the overall economy. The focus of today's hearing is on
    the Fed's authority to pay interest on reserve balances, which
    Congress created under the Financial Services Regulatory Relief
    Act of 2006 and directed the Fed to implement in response to
    the 2008 financial crisis.
    ---------------------------------------------------------------------------
        \1\ The prepared statement of Senator Peters appears in the
    Appendix on page 35.
    ---------------------------------------------------------------------------
        Commercial banks hold cash balances at the Fed known as
    reserves, that play an important role in keeping financial
    markets functioning. The Fed pays interest on those reserves,
    allowing the Fed to set target interest rates that affect rates
    on everything, from mortgages, to car loans.
        The Fed also receives interest payments from banks on the
    securities backing of those reserves, which the Fed then sends
    to the Treasury in the form of remittances. According to
    publicly available data in the past 16 years that the Fed has
    held this authority, it has actually remitted over $900 billion
    to the United States Treasury even after making interest
    payments.
        Although the last two years saw negative remittances,
    primarily due to the necessary responses in support of the
    economy during the COVID-19 pandemic, the Fed has recently
    stated that it expects its negative remittances to turn
    positive again very soon. Repealing this authority would not
    save any money for the taxpayers and without this authority,
    the Fed would lose control of its ability to set a floor
    interest rate for lending.
        Economists predict this would result in collapsing interest
    rates and much higher inflation, something we have quite enough
    of already. To restore rates, the Fed would need to shrink the
    level of reserves at an unprecedented speed and volume.
    Introducing volatility, comprising market resilience, and
    leaving banks prone to shocks.
        Stability is absolutely critical. American financial
    markets remain the envy of the world in most ballparks due to
    the stability, the efficiency and liquidity provided by the
    Fed. If banks did not receive these payments on their reserves,
    they would simply buy other government securities that the
    government pays interest on like treasury securities, and as a
    result, be more prone to economic volatility.
        Ultimately, this all comes back to affordability and making
    our economy work for small businesses and families. Economists
    argue that repealing this authority would disproportionately
    harm small and community banks and make borrowing harder for
    both businesses as well as consumers. Unfortunately, like so
    many things under President Trump, the Fed has been needlessly
    politicized. We are currently facing a dangerous ongoing threat
    to the Fed's independence. After repeatedly pressuring the Fed
    to lower interest rates, President Trump has tried to fire
    Governor Lisa Cook and has called Chair Jerome Powell to be
    replaced.
        These actions are politically motivated and Congress should
    stand up for the Fed's independence and ensure that monetary
    policy remains insulated from political pressure. Finally, Mr.
    Chair, while the oversight of the Federal Reserve is certainly
    important, this Committee I think has not held oversight
    hearings on numerous topics that are actually in our
    jurisdiction, including the Federal Emergency Management Agency
    (FEMA's) failure to responding to disastrous floods in Texas,
    this spring, persistent cyberattacks by our adversaries against
    Federal information technology (IT) and critical infrastructure
    networks.
        Or the administration's efforts on border security and drug
    trafficking. In fact, our colleagues in the House and the House
    Homeland Security Committee are actually sitting down right now
    as we speak with Secretary Noem across the Capitol to talk
    about threats posed to the homeland.
        A serious topic that certainly demands the attention of
    this Committee, not just the house Committee. Mr. Chair, so I
    hope we will also prioritize hearings with administrative
    officials in the near future so we can fulfill that
    responsibility. Again, to our witnesses, thank you for being
    here.
        Chairman Paul. It is the practice of the Homeland Security
    and Governmental Affairs Committee (HSGAC) to swear in
    witnesses. Will each of you please stand and raise your right
    hand? Do you swear that the testimony you will give before this
    Committee will be the truth, the whole truth, and nothing but
    the truth, so help you, God?
        [Witnesses answer in the affirmative.]
        Thank you. You may be seated. Our first witness will be
    Norbert J. Michel, Vice President and Director of Cato's
    Institute Center for Monetary and Financial Alternatives.
        Dr. Michel leads a team of nearly one dozen scholars that
    develop original policy solutions to expand freedom through
    improving financial markets and monetary policy. In addition to
    producing policy publication, his team regularly engages with
    policymakers on Capitol Hill. Dr. Michel, you are recognized.

     TESTIMONY OF NORBERT J. MICHEL, PH.D.,\1\ VICE PRESIDENT AND
    DIRECTOR, CENTER FOR MONETARY AND FINANCIAL ALTERNATIVES, CATO
                               INSTITUTE

        Dr. Michel. Good morning, Chair Paul, Ranking Member
    Peters, Members of the Committee, thank you for the opportunity
    to testify today. I am Norbert Michel, Vice President, Director
    of the Senate for Monetary and Financial Alternatives of the
    Cato Institute. The views that I expressed in this testimony
    are my own and should not be construed as representing any
    official position of the Cato Institute.
    ---------------------------------------------------------------------------
        \1\ The prepared statement of Dr. Michel appears in the Appendix on
    page 37.
    ---------------------------------------------------------------------------
        In my testimony today, I argue that it is time to wind down
    the Federal Reserve's balance sheet and once that wind down is
    complete, and the Fed's ability to pay interest on reserves.
    Importantly, these policy goals can be accomplished without
    harming the American economy. As part of its response to the
    2008 financial crisis, the Federal Reserve purchased large
    quantities of long-term treasuries and mortgage-backed
    securities.
        The Fed Securities holdings balloon from less than 1
    trillion to four and a half trillion and on the eve of the
    COVID-19 pandemic remained elevated at approximately 4
    trillion. Then a new round of purchases pushed this figure up
    to almost 9 trillion. As the first round of these purchases
    occurred, the public generally feared the Fed was stoking a
    massive inflation problem, and they were correct to be
    concerned.
        Under a traditional monetary policy framework, Fed
    purchases are equivalent to expansionary monetary policy.
    However, during this period the Fed also changed its operating
    framework to one that could no longer be considered
    traditional. The main feature was that the Fed started paying
    interest on banks reserves. This new feature received much less
    attention than the Fed's asset purchases themselves, partly
    because interest rates were historically low at that time.
        As many people recognize though, if and when rates
    eventually rose, the Fed would have to start paying large
    amounts of money on reserves, a move that would imperil its
    profitability and therefore its remittance to treasury. It
    would also put it in a politically difficult position.
        After the post COVID-19 rise in inflation, that time
    finally came, the Fed's interest payments increased
    dramatically and the rate of increase in interest expenses
    closely mirror the rate of increase in the IOR rate, the rate
    that the Fed pays out on reserves. This latter fact was not
    true in the late 2010's when the Fed raised the IOR but kept
    interest payments in check because it only paid interest on
    excess reserves as opposed to all reserves.
        A policy had changed during the pandemic. These large
    interest expenses resulted in the Fed's only recorded losses
    since 2008, and the only losses on record since the data has
    been available. Between 2023 and 2024, the Fed has lost nearly
    $200 billion and it will likely take years of future profits to
    offset those losses from these past two years alone. Profits
    that would not usually go to treasury.
        One obvious problem with this trend is that interest rates
    may not come down to their pre-pandemic levels, thereby failing
    to reduce the Fed's interest burden and allowing its financials
    to turn back to profit. However, regardless of the future path
    of interest rates, there are several other problems with the
    IOR framework that dictate it should be ended.
        For instance, this IOR framework provides government
    dollars to large financial institutions at risk-free interest
    rates, essentially giving banks a massive government handout.
    The average American has no access to this risk-free
    investment. Next, the IOR framework leaves banks with less of
    an incentive to borrow from each other or lend funds to the
    public resulting lowered activity in private markets.
        Then potentially large financial losses will also undermine
    the Fed's ability to support the banking sector and the U.S.
    government's ability to issue new debt. The losses create a
    potential complication for monetary policy because the Fed must
    increase the IOR in order to combat inflation even though every
    increase in the IOR increases the Fed's potential losses.
        Then last and perhaps the most dangerous issue is that the
    IOR framework effectively divorces the Fed's monetary policy
    stance from the size of its balance sheet. In other words, the
    Fed's asset purchases which increase bank reserves are no
    longer automatically associated with expansionary monetary
    policy and inflation.
        This feature increases the likelihood that the Fed will be
    used as a pawn of the Treasury, enabling the government to run
    even larger deficits and open new opportunities for political
    groups to pressure the Fed for direct funding, something that
    we have already seen start to happen. Congress should require
    the Fed to shrink its balance sheet in no more than 15 years,
    which is approximately the same amount of time it took to
    enlarge the balance sheet from 2008.
        Faster would certainly be better. The goal should be to
    reduce the Fed's holdings to no more than the pre 2008 share of
    the commercial banking sector, which was approximately 10
    percent. At that time, the Fed's authority to pay interest on
    reserves should be repealed. Thank you for your consideration.
    I am happy to answer any questions you may have.
        Chairman Paul. Our next witness is Ryan Young. Ryan is a
    senior economist at the Competitive Enterprise Institute. He
    specializes in trade, regulatory reform, antitrust policy,
    monetary policy, and other issues. He edited the essay
    collection, Adam Smith's Guide to Life, Loveliness and The
    Modern Economy, and his writing has appeared in USA Today, the
    Wall Street Journal, Politico, and dozens of other
    publications. Mr. Young.

       TESTIMONY OF RYAN YOUNG,\1\ SENIOR ECONOMIST, COMPETITIVE
                          ENTERPRISE INSTITUTE

        Mr. Young. Chair Paul, Ranking Member Peters, distinguished
    Members of the Committee, thank you for holding this hearing
    and inviting me to testify today. My name is Ryan Young. My
    work focuses on monetary policy, trade policy, and regulatory
    policy at the Competitive Enterprise Institute, a nonpartisan
    public policy organization that concentrates on regulatory
    issues from a free market perspective.
    ---------------------------------------------------------------------------
        \1\ The prepared statement of Mr. Young appears in the Appendix on
    page 46.
    ---------------------------------------------------------------------------
        I am pleased to speak to you today about a bipartisan goal,
    ending interest on reserve bank deposits. This is the practice
    of the Federal Reserve paying interest on account balances that
    other banks hold at the Fed. IORB was enacted in 2008 in
    response to the financial crisis. It has since proven to have
    few benefits and many drawbacks and it's time to end it.
        The two IORB problems I wish to highlight today are
    cronyism and inflation. First, cronyism, the Committee's report
    points out that, in 2024, the Fed paid about $180 billion in
    IORB to banks. While this number is likely to drop in 2025 and
    2026 due to lower interest rates, it's still a bad look for the
    Fed.
        IORB is free money for banks that don't need the help.
    Similar to Wall Street bailouts from past years, free IORB
    money encourages banks to take on risks they would otherwise
    avoid, and the taxpayer expense if they go bad. As we have
    found out the hard way several times over the years, extended
    excessive risk taking rarely ends well. If a recession or a
    financial crisis hits, IORB could be both a contributor to the
    problem and a prelude to more taxpayer bailouts.
        The money spent on IORB repayments has other potential
    uses. It could have gone to the Treasury instead. $180 billion
    is equivalent to about one tenth of last year's budget deficit.
    Savings from ending IORB could also have more than covered the
    Fed's 2024 operating losses of $114 billion.
        The second IORB problem I wish to discuss is inflation.
    IORB raises inflation risk in two ways. First, by potentially
    influencing the Fed's Federal fund rate decisions. Second, by
    influencing its open market operations policies. A high Federal
    funds rate already has unintended consequences such as higher
    interest rates on government bonds.
        This makes government debt more expensive to repay, and is
    one reason why the political branches often pressure the Fed to
    lower rates. IORB creates an additional unintended consequence.
    The higher the Federal funds rate, the higher the Fed's Board
    of Governors (BoG) has to set the IORB rate. Otherwise, banks
    will take their money out of the Fed and try to earn a better
    return elsewhere. The higher the IORB rate, the more likely is
    the Fed to incur an operating loss.
        In fact, IORB payments alone exceeded the Fed's 2023 and
    2024 operating losses. The Federal Open Market Committee (FOMC)
    has a tough job as it is. IORB makes its job even more
    difficult. IORB, especially at the large scale it has reached
    in recent years, can potentially influence the FOMC to set
    interest rates lower than it would otherwise prefer, in order
    to save money on IORB payments.
        IORB can also tempt the Fed to grow the money supply (M2)
    through open market operations, which can also cause higher
    inflation. If you or I were to buy government bonds, we would
    have to use our own money and take that money away from other
    potential uses. Unlike us, the Fed does not have to navigate
    that tradeoff. If it wants, it can buy government bonds with
    dollars that newly creates out of thin air.
        This is how the Fed can directly grow the money supply.
    This was also the main driver of COVID-era inflation. From 2020
    to 2022, the Fed added nearly $5 trillion to its balance sheet.
    This roughly quadrupled its usual rate of money supply growth,
    and the inflation rate roughly quadrupled to match. The Fed
    could do something similar to fund IORB payments.
        This would help it duck criticism from using IORB money to
    subsidize foreign and domestic banks. Rather than address its
    problems, the Fed could simply create more dollars in an
    attempt to have its cake and eat it too. This money supply
    growth has a tradeoff and that tradeoff is higher inflation.
    Fortunately, $180 billion will do far less damage than $5
    trillion did.
        But there is no need to make the FOMC's job even harder
    than it already is. Trial and error are essential to the public
    policy process. After a 17-year trial, we now know that IORB
    was an error. You now have the opportunity to fix it. Thank you
    for this opportunity. I look forward to your questions.
        Chairman Paul. Thank you. Our next witness is Brian
    Wesbury. He's the Chief Economist at First Trust Advisors L.P.
    Brian has been a member of the Academic Advisory Council of the
    Federal Reserve Bank of Chicago, as well as a fellow of the
    George W. Bush Presidential Center in Dallas. Previously, Brian
    served as chief economist of the Joint Economic Committee and
    has been ranked by the Wall Street Journal as the Nation's No.
    1 economic forecaster. Mr. Wesbury.

    TESTIMONY OF BRIAN S. WESBURY,\1\ CHIEF ECONOMIST, FIRST TRUST
                             ADVISORS L.P.

        Mr. Wesbury. Thank you, Chair Paul, and Ranking Member
    Peters. Thank you for inviting me. Members of the Committee, I
    would like to submit my testimony into the record. I am going
    to summarize it. As I kind of go through this just in my mind
    because listening to all of this, your Committee and your staff
    has done fantastic work.
    ---------------------------------------------------------------------------
        \1\ The prepared statement of Mr. Wesbury appears in the Appendix
    on page 49.
    ---------------------------------------------------------------------------
        I know pulling information out of the Fed is very difficult
    and so I really appreciate what you have done here. You have
    highlighted this interest on excess reserves. I would like to
    say that this is pulling on this thread is like unwinding the
    whole sweater, the fabric of this new monetary policy.
        It was started in 2008 during the great financial crisis
    and I believe it's supported by a myth. People believe that
    quantitative easing (QE) saved us during the great financial
    crisis and I do not believe that. I think it was a changing
    mark to market accounting rules that did. Nonetheless, it's
    lasted and so I want to think about what it really is.
        The Federal Reserve, at the same time, governments during
    COVID and during 2008 boosted their purchases of government
    bonds. The government is issuing a lot of debt. The Federal
    Reserve is buying it. If banks were forced to buy it, they
    would have a different risk profile as Ryan just highlighted,
    then the Fed does not care about losses. As a result, the
    government can issue more debt at a lower rate than it would be
    able to if it had to sell it into the private marketplace.
        What this did, in my opinion, is it allowed the government
    to grow bigger than it would have been able to if the Fed would
    not have followed this abundant reserve policy. The second
    thing is, it did not help stabilize the financial system. If
    you go back to the great financial crisis, the subprime loan
    losses were somewhere around $400 or $500 billion.
        The system today, as it stands, has losses of over one and
    a half trillion dollars. In other words, we have tripled the
    amount of losses in the banking system and at the Fed today
    versus what existed at the beginning of the great financial
    crisis. The other thing that's happened is that we have tripled
    the money supply since 2008. The annual money supply was $7
    trillion in 2008.
        Today, it's 22 trillion. Let me put that in stark terms. If
    you have a $100 bill in your wallet, 67 of those dollars were
    created in just the last 18 years. 33 of those dollars were
    created in the previous 200 years. That's how much money we
    printed and that's why we ended up with the inflation that we
    have. This is what's created the unaffordability problem
    because people with assets, one, if you already own a home,
    your home grows in value. If you own equities, your equities
    went up.
        If you do not own a home or equities, you just face higher
    inflation. I believe this policy has created more inequality in
    America than any government policies we have ever followed in
    our history. As a result, I think it's undermined our political
    dynamic. It has created haves and have nots. It has created a
    divide between older generations that have built up assets and
    younger generations that haven't.
        As a result, I believe this policy has been a complete
    failure in our system. It's created inflation, it's created
    more risk, it's also created this appearance of paying private
    banks and foreign banks money. It has taken the risk away from
    the government of issuing debt into the private sector. I think
    it needs to be unwound and unwound completely and never allowed
    to come back again. Thank you very much for the time.
        Senator Peters. Our next witness, Dr. Kohn, formerly served
    as a member and then Vice Chair of the Federal Reserve Board of
    Governors from 2002 to 2010. Previously, he held several staff
    positions, including Secretary of the Federal Open Market
    Committee and Director of the Division of Monetary Affairs.
        Dr. Kohn also advised Federal Reserve Chairman Ben Bernanke
    throughout the 2008 and 2009 financial crisis and former
    Chairman Alan Greenspan. He received a bachelor's degree in
    economics from the College of Rooster and more significantly a
    Ph.D. in economics from the University of Michigan. No one
    would question the academic rigor of your studies at that fine
    institution. Dr. Kohn, welcome to the Committee. Thank you for
    your expertise. You may proceed with your opening remarks.

     TESTIMONY OF DONALD KOHN, PH.D.,\1\ ROBERT V. ROOSA CHAIR IN
     INTERNATIONAL ECONOMICS AND SENIOR FELLOW, ECONOMIC STUDIES,
                         BROOKINGS INSTITUTION

        Dr. Kohn. Thank you, Senator Peters. Thank you, Chair Paul
    for inviting me. In my view, the payment of interest on reserve
    balances serves critical public policy purposes and should be
    retained. IORB is required to enable the Federal Reserve to
    take actions to meet its legislative monetary policy mandates
    for maximum employment and stable prices.
    ---------------------------------------------------------------------------
        \1\ The prepared statement of Dr. Kohn appears in the Appendix on
    page 55.
    ---------------------------------------------------------------------------
        When the economy and employment are weak, the Federal
    Reserve normally reduces its target for short term rates to
    stimulate spending. Twice in the past 20 years, the Fed has
    lowered its target to zero but recovery from recession still
    has been slow or uncertain. In these circumstances, to reduce
    longer term interest rates further to encourage spending and
    job creation, avoid persistent deflation, the Fed purchases
    longer term government securities.
        Those purchases create a large volume of reserves and when
    it comes time to raise interest rates, inflation fighting
    depends on raising the IORB, which puts a floor under market
    interest rates. IORB also supports the Federal Reserve's
    ability to foster financial stability. It enables the Federal
    Reserve to make purchases to stabilize Treasury agency and MBS
    markets when they are disrupted, threatening the flow of credit
    to public and private borrowers.
        The market seized up in late 2008 and again in the spring
    of 2020. Because of IORB, the Federal Reserve was able to step
    in, make purchases of securities to restore market functioning,
    assure credit flowing to businesses and households. They were
    able to do that without losing control of monetary policy.
        IORB means the Fed can supply reserves to enhance the
    resilience of the banking system to unexpected adverse
    liquidity shocks, such as deposit runs; deposits at the Fed are
    the safest, most liquid assets banks can hold. IORB means that
    banks see reserves as a viable source of liquidity to manage
    risks without harming the bottom line.
        With IORB, the Fed can meet their demands for this asset
    without sacrificing its ability to control short-term rates for
    monetary policy purposes. Being able to use interest bearing
    deposits at the Fed to manage liquidity is especially important
    for smaller banks.
        Larger banks have access to a much wider variety of
    instruments to meet unexpected outflows. IORB does not result
    in a windfall to the banks. Banks have to fund their holdings
    of reserves with deposits or borrowing just as they do with
    other assets they hold. Banks pay interest and face other costs
    associated with those sources of funding.
        The rate paid on reserves is very close to the rate on a
    range of other short-term instruments which banks and others
    can borrow and invest. Moreover, any individual bank can
    increase its holdings and reserves by raising its deposit rate
    to attract new funds and leaving the funds in its reserve
    account.
        If the rate paid on reserves offered banks an excessive
    profit, increased competition in our market system among banks
    for deposits would push up bank funding costs offsetting that
    profit. IORB will not result in a net cost to the treasury over
    the long run. While a larger Fed balance sheet means the Fed is
    supplying more reserves to banks on which it pays interest, it
    also means that the Fed is holding more government securities
    purchase with those reserves and it earns interest on those.
        Fed interest income and expense can differ significantly in
    some periods. This is a temporary condition. Over time the
    effects of a larger Fed balance sheet on interest payments to
    banks and interest receipts on security should be roughly
    offsetting. IORB and ample reserves do not crowd out consumer
    or business lending. Deposits are the counterpart of those
    reserves.
        When a bank receives the deposit, it compares the risk
    adjusted returns on various uses of the deposit. Before IORB, a
    bank might compare making a loan to lending to another bank in
    the Federal funds market. Today, the bank compares making a
    loan to holding onto the deposit at the Fed. IORB is almost
    identical to the funds rate. So it has not altered this
    calculus about making loans. While not allowing the Fed to pay
    interest on reserve balances would have little effect on
    treasury income over time or bank profits, that would handicap
    the Fed's ability to promote economic and financial stability.
        It should be left in place. If Congress wishes to raise
    additional taxes from banks, it should do so directly, not by
    forcing them to make interest free loans to the government.
    Thank you, Mr. Chair.
        Chairman Paul. Thank you for your testimony. I would like
    to enter into the record the report\1\ produced by the
    Committee majority as part of this investigation. Without
    objection, these records will be entered into the hearing
    record. We will now proceed to questions where each Member will
    have five minutes. We will start with Senator Johnson.
    ---------------------------------------------------------------------------
        \1\ The report submitted by Senator Paul appears in the Appendix on
    page 61.
    ---------------------------------------------------------------------------

                  OPENING STATEMENT OF SENATOR JOHNSON

        Senator Johnson. Have you all read the Creature from Jekyll
    Island? Have you all read it? The basic premise of that is the
    Federal Reserves, a cartel of the big banks, right? It
    shouldn't be there. And to a certain extent, I find this debate
    very confusing. I think part of it is we shouldn't have a
    Federal Reserve. We should run monetary policy a different way.
        I am not sure how you do that. I don't think anybody really
    understands monetary policy. We try things and they do not
    work. But hear me out. Tell me where I'm wrong. If the Fed runs
    a $200 billion loss because it's paying interest on these
    reserves, it's basically hiding a $200 billion loss that
    otherwise would be shown on our books.
        Instead of a $1.9 trillion deficit, we have $2.1 trillion
    deficits. Is that basically true? We are allowing this
    supposedly independent agency--I don't think it's particularly
    independent, but it's running a $200 billion deficit while
    fiscally we are running $1.9 trillion deficit. It's a shell
    game. Where are we doing it now? I understand the impact
    potentially on inflation is it allows us to run higher
    deficits.
        Because we are kind of hiding that interest expense.
    Personally, I do not think that would restrain Congress. I
    think we would just run a $2.1 trillion deficit. So where am I
    missing this? Because I also hear the arguments from other Fed
    presidents that, again, if they are not paying interest on the
    reserves, they will just buy treasury bill anyway.
        Again, that's where the government is on the hook for
    another $200 billion as Mr. Kohn talked about. Industries are
    pretty equivalent. So, I guess, where am I wrong? Briefly,
    please.
        Dr. Michel. Sure, I would not say that you are wrong. I
    think you could absolutely look at it and you can make an
    argument that you should look at a unified Federal budget and
    there would be no problem there at all. It is either in one
    place or the other right now, but it's all in the same place.
        Senator Johnson. OK. Again, you could all get your
    microphones a little bit closer because it's kind of hard to
    hear you. Mr. Wesbury.
        Mr. Wesbury. The United Kingdom takes the loss--the Bank of
    England has the same loss because they pay interest. They are
    paying more in interest to their banks than they are earning
    from the bonds that the Bank of England owns. They take that
    loss and put it into their deficit. In fact, they have had a
    big political fight about how they are able to increase
    spending because the central banks are losing money.
        Senator Johnson. This problem masking the true deficit,
    $200 billion. I would argue that's the problem. I don't think
    it's a master problem. Mr. Wesbury you mentioned that we have
    increased the money supply.
        Here's the fact. A dollar you held in 1998 is worth 51
    cents. A dollar you held in 2014 is worth 74 cents. A dollar
    you held in 2019 is worth 80 cents. But the money supply
    increased a lot more than that. What's the difference? Why is
    it a direct relationship?
        Mr. Wesbury. Because the Federal Reserve, as they have
    added money to the banking system through this process of
    quantitative easing has instituted heavier capital requirements
    and liquidity rules on banks. In other words, they have flooded
    the system with money but then they have forced the banks to
    hold on to that money.
        As a result, it didn't turn into inflation as much as you
    might have thought. Back after the 2008 quantitative easing,
    everybody thought inflation was going to pick up and it didn't.
    However, it did during COVID and the difference was----
        Senator Johnson. That's just my point.
        Mr. Wesbury. Yes.
        Senator Johnson. Everybody thought inflation didn't----
        Mr. Wesbury. Yes.
        Senator Johnson. Again, that's what's so confusing. This is
    why I focus on fiscal policy. I mean, to me, the problem is we
    are running these enormous deficits. We are going to finance it
    one way or the other. Either finance it through the Fed or we
    finance it through the treasury and selling bonds. We are
    screwed either way.
        We need to get our fiscal house in order. We can argue
    about this. Again, I don't know if we should pay them or not. I
    don't think it really makes that much difference. I understand
    the argument, it hides it that in theor, would increase
    inflation. Although we thought it would and it did not. Again,
    my point would be--I am running out of time, is we need to
    focus on fiscal problems, our massive fiscal deficits and how
    we finance it. It's kind of a horse of piece.
        Mr. Wesbury. Dr. Kohn, I think wanted to respond.
        Dr. Kohn. I just wanted to point out to the Senator that
    there's never been a really tight relationship between money
    supply and inflation. There's been a long-term relationship but
    it's not that tight. As you and Brian talk, there was a lot of
    discussion in the 20 teens about how this blow up in the
    balance sheet and in the money supply was going to cause
    inflation. Inflation was very low the whole time. People were
    surprised at how low it was.
        Senator Johnson. Which again, underscores my point. I
    really don't think we understand monetary that nobody does.
    It's a guessing game.
        Chairman Paul. I would also say that while there's not an
    exact mathematical correlation, increasing the money supply is
    what causes inflation. I don't think that's disputed. Mr.
    Wesbury.
        Mr. Wesbury. Yes. I did not expect inflation after 2008
    because the M2 was contained with regulatory rules. I did
    expect inflation during COVID because we relaxed those
    regulatory rules and M2 exploded. It was one of the easiest
    forecasts I have ever made in my career. Chair Paul is exactly
    right. M2, it's money printing that causes inflation.
        That's what worries me about quantitative easing is we have
    flooded the system and if we let it out then it becomes
    inflation. Then the second quick point, it's not about interest
    rates because Chair Bernanke held interest rates at zero for
    seven years, and we did not get inflation. Chair Powell only
    held them at zero for two years, and we had nine percent
    inflation.
        It's not about rates, it's about the money supply. That's
    why taking away the ability to pay interest on reserves will
    not cause inflation. That's not what causes inflation. It's the
    money supply that does.
        Chairman Paul. Senator Peters.
        Senator Peters. Dr. Kohn, focused answer, just try to
    answer something related to exactly what we are dealing with
    right now. You emphasized in your testimony the importance of
    interest on reserve balances as a tool and monetary policy. For
    the Committee and all of you talked about this and you have
    been trying distill it down for us.
        Why is this authority necessary to retain in order to
    maintain a strong economy? What are the risks if we repeal it?
    How would you summarize that quickly for us?
        Dr. Kohn. I think there are a couple of things there,
    Senator Peters. One, if the economy is very weak and the Fed
    reduces its interest rates to zero, as Brian was just talking
    about, and the economy remains weak or they are concerned that
    the economy will remain weak--this is the 20 teens--you need to
    do something else to stimulate spending.
        You need to lower mortgage rates to get people to buy
    houses, to get lower interest rates, to get people to buy cars,
    et cetera. That's what QE does. That's what buying the
    securities does. So buying those securities helps stabilize the
    economy and promote employment. Once the Fed does that, it
    really needs the interest on reserves then to tighten policy to
    fight inflation as it did in 2022.
        It was a bit late to that game. I agree and I have made
    that criticism publicly but it did fight. It did it with IORB.
    Without IORB, it would not have been able to stabilize the
    system when COVID hit, which is a big difference there. A lot
    of COVID distortions and it would not have been able to fight
    inflation. It's brought inflation from six down to three with
    IORB. So very important for stabilizing the economy and
    fighting inflation.
        Senator Peters. You made the argument why it's important. I
    would like to turn the idea that we have heard that banks are
    receiving a windfall as a result of this. How would you respond
    to those would argue that?
        Dr. Kohn. Banks have to get those reserves somehow. The Fed
    goes out and it buys securities from someone holding treasury
    securities. That person then takes the deposit and puts it in
    the bank. That person isn't going to deposit it at 0.5 interest
    rate, right? It's going to want a rate that's somewhat
    comparable to the securities that's sold to the Fed.
        The bank then has the deposit at the Federal Reserve. The
    bank has attracted a deposit that pays almost what it's being
    paid at the Federal Reserve. You can't compare the money that
    the Fed pays to the banks to net interest margin. You have to
    talk about what the banks have paid to get that money. My view
    is they are paying something comparable to IORB in order to get
    that money. The net profit to the banks is quite small.
        Senator Peters. In fact, those remittances are back to the
    Treasury, which I mentioned in my opening comments. I also
    mentioned that the Fed is asserting that it's going to return
    to positive remittances back to the treasury in the near
    future. Would you agree with that and explain to us what that
    means for the taxpayers?
        Dr. Kohn. I think the Fed's recent weekly balance sheet
    suggests that it is already earning profits. The amount of
    accumulated losses that it's showing has started to go down
    very slowly. As interest rates go down and they went down
    further yesterday with the FOMC's decision, the Fed's profits
    will pick up. The Fed is already on a path to recoup the losses
    that it made and start putting money back to the Treasury.
        Senator Peters. A final point--my time is running out. To
    the average person, if you are a small business or a family and
    you are hearing this debate about interest on these reserve
    balances, how does it impact them? Why is it a good thing that
    this law is in place and are there concerns that you have?
        Dr. Kohn. I think it's a good thing because it helps. This
    goes back to the first question, Senator Peters. It goes back
    to what it enables the Fed to do. It enables the Fed to protect
    economic stability and financial stability. Without that, the
    recession in 2008 would have been much worse. The recession
    after COVID hit and the disruption in financial markets, the
    financial markets were not working.
        When you are not working, you can't get credit to
    households and businesses, small businesses, or large
    households, et cetera. The Fed had to step in and buy those
    securities in order to restore functioning. IORB enabled it to
    do that knowing that when it was time to fight inflation, they
    still had the tool to fight inflation. Without IORB, inflation
    might be higher, the economy might be weaker, the stagflation
    could be worse.
        Senator Peters. Thank you. Thank you, Mr. Chair.
        Chairman Paul. Senator Lankford.

                 OPENING STATEMENT OF SENATOR LANKFORD

        Senator Lankford. Thank you. Thanks for the conversation on
    this. This is important because we are dealing with the
    financial future of the country. The two big issues here,
    Congress has got to be able to work on getting our debt down,
    first, our deficit down, our debt down.
        All these things are patchwork with the Federal Reserve
    trying to be able to figure out how to be able to manage
    economy with the amount of debt that we are currently carrying
    as a Nation. Second thing on this though, is this is an
    entirely new system that's out there. We are talking the last
    15 years, the rules have changed and everything, the amount of
    quantitative easing, what's actually having the interest on
    reserve balances.
        This is an experiment we really don't know where this goes
    50 years from now, 35 years from now, and some of the
    acceleration. It's entirely reasonable for us to be able to
    have this dialog, to be able to talk it through and to be able
    to deal with. Let me try to deal with a couple of things on
    this. One, is the interest on reserve balances given to foreign
    banks.
        Obviously, that is in direct competition with our domestic
    banks obviously, but it's also what would have been American
    tax dollars going back into the Treasury actually going to a
    foreign bank to be able to stabilize their reserve balance as
    well. What effect does that have on our American economy for
    that much money? Does anyone know the amount of interest on
    reserve balances Federal Reserve has paid to foreign banks?
        Dr. Kohn. I think this was in the study that that Dr. Paul
    released and it is substantial.
        Senator Lankford. Substantial.
        Dr. Kohn. Because the foreign banks do hold lots of
    deposits at the Federal Reserve. It serves a purpose for United
    States and foreign citizens. The foreign banks help to
    facilitate transactions between countries. They help U.S.
    exporters, for example.
        Senator Lankford. But if we go back 15 years ago, it was
    bank to bank that were actually dealing with this rather than
    the Federal Reserve being able to hold it over.
        Dr. Kohn. Right.
        Senator Lankford. My bigger question on this is, if we were
    to, let's say, slowly taper this away, there's been some
    arguments to say six months is too fast. Dr. Paul is always in
    a hurry to solve every problem. They have said, do you know
    what? His bill's just too fast to be able to implement on this.
    We need more time than that. When I asked the question of banks
    and to say, how much time you need, it's always as much time as
    we can get.
        But then my second question to them is, what would you do
    instead? Every one of them I have talked to said the same
    thing, ``We would buy treasuries.'' I was like, ``Why is that a
    bad thing for our economy, for banks to be able to buy into
    treasuries?'' We are selling treasuries already at record
    numbers out there. We need consistent buyers on this. Why is
    this a bad thing for us to switch from interest on reserve
    balances to actually banks actually buying treasuries?
        Dr. Michel. It's not a bad thing. If they want to buy
    treasuries, they can buy treasuries, then that's fine. If I
    want to buy treasuries, I can buy treasuries, but I cannot take
    the proceeds from my sale of treasuries and park them at the
    Fed and earn exactly what I was earning when I had the
    treasuries. That's why it's a rainfall.
        Senator Lankford. Right. Do you anyone make a comment on
    that?
        Dr. Kohn. You are talking about whether the Fed should be
    buying the treasuries or the banks.
        Senator Lankford. Yes, the banks.
        Dr. Kohn. Right. So, the same number of treasuries need to
    be sold to fund the deficit that you and Senator Johnson were
    talking about. So that, and the question is whether it's the
    Fed or the banks. Certainly before 2008 the banks found ways of
    making these transactions, it was perhaps a bit more cumbersome
    than it is today, with the interest on reserves.
        So yes, they will find a way of doing the same things, but
    you will handicap the Federal Reserve. Remember, Congress
    actually authorized this in 2006. I testified in 2004 in favor
    of paying interest on reserve. So I'm a little consistent over
    time. And my point then was not paying interest on reserve
    balances was a tax on the banks. The banks naturally were
    trying to avoid the tax as we all do.
        They avoided the tax by keeping deposits lower by
    discouraging certain kinds of deposits where they have to hold
    reserves and by passing on that cost to borrowers and lenders.
    I think the Congress recognized the inefficiencies of not
    paying interest on reserves and authorized the Fed to do it
    with no expectation that a 2008 would come about.
        Senator Lankford. Right. Yes, the challenge is just for
    basic safety and soundness of a bank, there is a good reason to
    be able to keep significant reserves in a bank. But to be able
    to say that just because we require you to be safe and sound,
    that's a tax on the bank, that's a part I guess I don't agree
    with.
        Dr. Kohn. When we were not paying, so we said to the banks,
    you have to keep deposits at the Federal Reserve paying zero.
    You have to make an interest free loan to the government.
    That's a tax.
        Senator Lankford. Mr. Wesbury you were about to say
    something as well.
        Mr. Wesbury. Yes. From the beginning of the Fed all the way
    through 2008, we did not have banking problems because banks
    had too fewer reserves. That's not why we had banking problems.
    The great financial crisis did not come about because banks had
    too few reserves. That's not what was the problem. The second
    point I would make is that quantitative easing didn't save the
    economy either.
        We passed quantitative easing in September 2008, and the
    market fell another 40 percent after that in the next nine
    months. It wasn't until March 2009 that everything turned
    around. The one thing that changed then was we altered this
    mark to market accounting rule. That was the real problem with
    the banking system.
        What the Fed did is they took advantage of that crisis and
    grew their balance sheet massively from 850 billion to today
    over almost $7 trillion. The second point I would make is, yes,
    the bank should own the treasury bonds. Instead, what's
    happened is that the Fed buys them and. On the Fed's books,
    there are $800 billion of losses from the treasury bonds it
    bought during 2008 and then again during COVID.
        What they really did is they took the risk out of the free
    market and put it on the Fed's balance sheet. Because the Fed
    does not care about losses, they do not mark them to market,
    they can print money to take care of the losses. What this has
    done is distorted the economy and allowed us to spend more as a
    nation than we would if we had to pay the real price of that
    borrowing.
        Senator Lankford. Thank you.
        Chairman Paul. Senator Scott.

                   OPENING STATEMENT OF SENATOR SCOTT

        Senator Scott. Mr. Chair, thanks for doing this. Thanks for
    holding this hearing. I think Jay Powell is a disaster. If you
    just look while--it started a little bit before him, but the
    balance sheet went from what you said, Mr. Wesbury, 800 what
    billion dollars to now it's got to 9 trillion?
        Mr. Wesbury. Yes.
        Senator Scott. Now it's starting to increase it again.
        Mr. Wesbury. Yes.
        Senator Scott. They are going to announce it, 40 billion
    dollars more a month. I mean, we do not have a financial crisis
    today. I have been trying to get an independent inspector
    general because nobody will even investigate the fact that they
    have had insider trading issues, stuff like that there. It
    makes no sense to me.
        Mr. Wesbury, let me ask you my first question. What's the
    balance sheet and what's the liabilities? What's the spread
    right now?
        Mr. Wesbury. At the Federal Reserve?
        Senator Scott. Right.
        Mr. Wesbury. The balance sheet is now 7.6 times larger than
    it was back in 2007. It's six and a half trillion dollars. We
    have gone from 850 billion to six and a half trillion. The
    Federal Reserve owns the bonds on the other side, but they have
    an $800 billion loss on those bonds----
        Senator Scott. Marked to market? If you were a bank?
        Mr. Wesbury. Yes, they would be 850 billion in the hole.
        Senator Scott. Right. The capital count's only like $45
    billion, $43 billion at the Federal Reserve anyway?
        Mr. Wesbury. They have lost 40 times their capital. I have
    tried to get an answer to a question is how does the Fed keep
    the lights on? Because they have lost 850 billion on their
    portfolio and they are losing $180 billion this year.
        Chairman Paul. How do they finance this year, which they
    are financing on other profits as well.
        Senator Scott. Yes. And he's losing about $200 billion a
    year, right? OK. He's funding that by just issuing treasuries,
    right?
        Dr. Kohn. By issuing reserves, basically by writing the
    paycheck.
        Senator Scott. I mean, he just gets to keep----
        Dr. Kohn. The Fed is not a profit-making institution.
        Senator Scott. Wait. Before Powell, had sent money every
    year, right? They sent money every year to the treasury?
        Dr. Kohn. The Congress has given the Fed certain
    responsibilities for stabilizing the economy and stabilizing
    prices and protecting the financial market. These purchases and
    those losses were incurred in the process of meeting the goals
    that you, the Senate, and the House set for the Federal
    Reserve. You did not set a goal of profit for the Federal
    Reserve.
        Senator Scott. Yes, and I think that's legitimate. But they
    failed in doing that. As Mr. Wesbury said, they bought these
    treasuries to try control all the interest rate through the--
    not just short term, but 10 year, and 20, and 30 year, OK? And
    cause misallocation of capital. I mean, complete misallocation
    of capital is what he's done, and no accountability.
        Here's what I am getting. Why do they have reserves in the
    first place? Let's go through that. They have reserves because
    in a normal business, you have to have reserves. I have owned
    manufacturing companies, OK? If I went to the bank and said, I
    want you to lend me a hundred percent of the money, they would
    have laughed at me. Then the bank said, ``OK, we will lend you
    money, but we are not going to pay you to hold the reserves you
    have to hold.'' Right? Isn't that the same thing? How's it any
    different? Any of you? I mean, I never get this, why we are
    paying them to hold what a normal business has to hold and
    their leverage to the hilt.
        Dr. Kohn. For decades, banks held about 10 percent
    reserves. Now by doing quantitative easing, we bumped that up
    to over 30 percent and then we pay them to hold them.
        Senator Scott. They use our guarantee to get deposits. They
    use the Federal Government's guarantee to get deposits and then
    we pay them to get the reserves to justify us giving them a
    Federal guarantee. But I used to borrow money from banks. They
    didn't say, ``Well you got to hold capital, 20, 30 or 40
    percent capital, and I am going to pay you for that. That's
    what is crazy about this.
        Then the fact that they keep losing this money and they act
    like it's going to change. I do not get how it keeps saying,
    ``It's going to get better. Well, how?
        Dr. Kohn. As interest rates come down, the amount of money
    they are paying the banks will come down and the money they are
    earning on their portfolio comes down much more slowly because
    it's a longer-term portfolio.
        Senator Scott. If that's true, then why would they have to
    yesterday announce agreement to start buying another $40
    billion of treasuries?
        Dr. Kohn. Because the funding markets were being disrupted
    because reserves had dropped low enough that the banks were not
    arbitraging back and forth in these funding markets. They are
    increasing those disposal----
        Senator Scott. It is because they could not get the bank.
    The banks were not happy with the interest rate they were
    getting. So now they have to buy up the treasuries to deal with
    that.
        Dr. Kohn. We have to remember that the Federal Reserve is
    the one who creates the reserves. The banking system does not
    control the amount of deposits at the Fed, the Fed controls the
    amount of deposits at the Fed. The banking system can pass
    those deposits around.
        Senator Scott. Let's make it real simple. We are paying
    banks to hold treasuries or we are paying them interest, one or
    the other, right?
        Dr. Kohn. Right.
        Senator Scott. Right. I just don't get why we are paying on
    capital and how that helps. Like in my State, if you go around
    my State, the rich are doing fine, right? I live in Naples,
    Florida, they are doing fine. I talk to them, they are doing
    great. Do you know who is getting creamed because of the
    Federal Reserve? The poor. Mortgage rates are up. As they keep
    playing with short term entry rates, what's happened to the 10
    year and 30 year? It's gone up.
        Dr. Kohn. Yes.
        Senator Scott. Now they have to try to play that and that's
    been building the balance sheet again. This makes no sense.
    Since
    Powell's started down there, I mean, you said inflation was
    transitory. It wasn't. What they have done is cost massive
    inflation in this country. Stop doing it. I don't get this
    stuff. Why we just allow them to pay interest to banks, keep
    buying more treasuries.
        It just doesn't make sense. They are out of control. Do you
    guys disagree? Am I looking at it differently than you look at
    a normal business?
        Dr. Michel. Yes. It's not a normal business. It's part of
    the government, which is why Senator Johnson is right. You
    should look at it on a unified basis. The issue here is that we
    should take away the market distorting piece of this and let it
    be priced in accurately.
        Senator Scott. But the market work?
        Dr. Michel. Yes.
        Senator Scott. I wanted to borrow money at zero. When I was
    in business, I got stuck with the darn banks what they wanted
    to charge. Why don't we let the Federal Reserve do that? Let
    the market work. I am sorry.
        Chairman Paul. No, that's good. We are going to continue
    for a walk. I would I like the discussion. Dr. Kohn, you said
    that really one of the primary goals of the Federal Reserve is
    not to make money. That's correct. You would have inflation and
    unemployment, but there are infinite amount of ways they could
    address those goals.
        You might also argue that a central bank that loses money
    might not be of course, for bragging about or that it might not
    be part of your goals to have a central bank that loses money,
    that it might not be comforting or accentuate or help with the
    idea of stability within the economy. I am going to throw out a
    question that I think I just want to hear the response, and it
    may be a little bit off the wall.
        What if we had a banking system that was just based on
    fraud and lack of fraud? If I give you money and you decide to
    loan it, you have to pay me interest and we have a contract. I
    am not going to come get my money for five years and you are
    going to loan it and that's all you would loan. We did not have
    any other rules.
        The interesting thing is this, about 25 percent of money
    that's loaned out is checking account money. But you don't have
    a contract with me. The reason why the whole system is always a
    house of cards and could go under is if everybody wants to get
    their checking account money, it's not enough money.
        Basically, we have a fraudulent system. Fractional reserve
    is a fraudulent system. But what if you did nothing else? I am
    not asking you to advocate for the policy. I just want to know.
    About 25 percent of the deposits are checking, you could still
    loan some of that if you tell me I can only remove 90 percent
    of my checking that you will pay me a little bit of interest.
        But right now, you take my checking account money and
    basically don't pay me anything and the banks get to make money
    on it. What if we just had a system of banking based on fraud?
    We will start with Dr. Michel.
        Dr. Michel. If I understand where you are going----
        Chairman Paul. You go and loan out money that you have
    permission to loan out and you got to make an agreement with me
    if you are going to loan my money out and give it to somebody
    else. I am going to forego it, you got to pay me some money and
    you are going to take a portion of it. But I did not make that.
    When I put my money in my checking account, I want it all
    there, but it's not all there because you are loaning it out.
    It is a fraud, the banks are committing a fraud every day by
    loaning out my checking account money.
        Dr. Michel. I mean, that is disclosed. I wouldn't call that
    fraud, but if----
        Chairman Paul. What if you weren't allowed to loan out
    stuff you did not have permission to? Let's assume that would
    be good----
        Dr. Michel. If you weren't allowed to loan out stuff that
    you did not have permission to loan out, I would be OK with
    that.
        Chairman Paul. I guess it's too far outside the box. Mr.
    Wesbury.
        Mr. Wesbury. I am going to take this in a little different
    way. We have the Federal Deposit Insurance Corporation (FDIC)
    insurance right now, so everybody's covered to $250,000. I have
    always argued that we should get rid of that. Like that
    encourages banks to not--actually, Silicon Valley Bank went
    under, we covered every penny of all their deposits.
        What we should have is a system of gradation. I am a bank,
    you give me your money, you want no risk, I take it and I buy
    treasury bills. Then you only earn two percent. You will take
    some risk. I buy half treasury bills and I make some loans with
    the others. Now you earn three percent or you want all risk,
    and I make all loans and you make four percent and you get to
    choose.
        Then on the way out the door, you could buy insurance from
    Goldman Sachs. They have a desk at the door. You just deposited
    your money. You can get private insurance. What you are really
    getting to is where the depositor has control over how the
    money is used. That's a system that's a free market system of
    dealing with insurance.
        Right now, we have government insurance on banking
    deposits, and that can lead to really risky bank behavior.
        Dr. Michel. I think that's called mutual funds, isn't it?
        Mr. Wesbury. It is. Yes.
        Dr. Michel. Those things are available. I wouldn't say it's
    based on fraud, Dr. Paul. I would say there is liquidity
    transformation in the system, and there always has been in
    which the banks lend out at a longer term than they get their
    funds in and demand deposits or savings deposits or short-term
    deposits. And that creates risk.
        Our country was subject before 1913, before the Fed was
    founded to periodic recessions, very severe recessions. When
    there were runs on the banks, the Fed was created to have a
    lending facility so the banks could meet those runs and
    wouldn't tighten the credit system and create very severe
    recessions. There is a risk in the system. We need to make sure
    the banks are resilient and can take the risk and understand
    the risk and the deposits that the Fed are----
        Chairman Paul. The reason there is a fraud that exists is
    that if a hundred percent of people want their checking account
    money in every bank in America tomorrow, it's not there, right.
    We still are liable for bank ones. The government just pays
    sort through the FTIC and we still do have bank runs on
    occasion. We have had some of these crises going back to the
    issue of the money supply tripling.
        It's always fascinating me, I know it's not arithmetic. It
    isn't exactly, you don't triple it and have a third, prices go
    up as triple. Some of that, you could argue that the IORB is,
    if you are going to have massive inflation, is a useful tool.
    But the opposite argument of that is if you have this useful
    tool, you are going to have a lot of inflation.
        It's a way to make inflation not so bad when you are going
    to pump tons of money into the system. But the counter argument
    would be maybe you shouldn't be pumping tons of money into the
    system. It's the same way with the Federal Reserve. We have
    many people out there, you may not know them, but think we
    shouldn't have a Federal Reserve.
        But I always tell them, yes, if we had a balanced budget
    every year, we probably could. Artificial Intelligence (AI)
    could run the system, have one or two percent inflation a year,
    and tell everybody what's going to be, it would be very
    predictable. We would not have any ups and downs, swings of
    this. It just is what it is. You would have great
    predictability, but you would have to balance your budget each
    year, so you did not have to have these wild swings.
        That was the whole thing of the pandemic, was this massive
    amount of borrowing and then all the flooding of money in
    there, everybody got free checks. It was a terrible thing we
    did. None of it was necessary, including the whole science
    behind making everybody crazy over COVID. Sure, it was bad, but
    it wasn't anything like the response to it. The response was
    insane.
        But going back to the inflation issue, I have just one
    other question, just sort of for the panel is, I have always
    wondered whether some of the reason we do not have as much
    inflation as the money supply created, or at least some of
    this, is that we export inflation in the sense that we import
    more than we export. So, we are always sending dollars
    overseas, over goods.
        It's an enormous amount of money. I know it equilibrates
    within the system, but we have entire countries that are on the
    dollar standard now. As we inflate, there are whole countries
    in Africa are, the only thing you see change in hands is
    dollars, South America the same way. So is some facet of the
    lessening of inflation that all those dollars aren't chasing
    American goods. We export them and there chasing worldwide
    goods. We do not have quite the impact of inflation that we
    would have with the tripling of the money supply. Why don't we
    just go down? I will start with Dr. Michel.
        Dr. Michel. From the studies that I am familiar with, I
    would say, no, that's not the primary reason.
        Chairman Paul. Ryan.
        Mr. Young. I would say dollars come back to the United
    States that come abroad generally in the form of foreign
    investment. If our countries choose to dollarize their
    economies, whether it's by importing dollars from here----
        Chairman Paul. I guess the question could be some of that
    investment goes into the stock market. The stock market may
    have inflation, but the consumer price index isn't. I mean,
    that's what I'm asking. Could you be shifting some of it away
    from consumer price index and you see inflation in the stock
    market, but Mr. Wesbury?
        Mr. Wesbury. Yes, there's a number of ways that the amount
    of money does not always equal the amount of inflation and it's
    productivity. We never know where the money can go into--there
    are countries that are dollarized, they completely use dollars.
    And so that money is out of the system and that means money
    growth doesn't matter as much. But a question or a point you
    just made before, I want to highlight something. Between 2020
    and 2022, COVID, the Federal Government issued $7 trillion
    worth of debt. The Federal Reserve bought 45 percent of that
    debt.
        This is monetizing the debt. The Fed always says they don't
    coordinate with the Treasury. I would argue there's probably
    not a phone call that says, we are going to issue this, you are
    going to buy that. But isn't it interesting that quantitative
    easing happens at the same time we pass these huge spending
    bills? Then the Feds ends up buying over half of that debt.
        The Fed does not have the same risk. They have a different
    risk tolerance than the banking system would. They will pay or
    accept a lower interest rate than the market would have in
    order to do this. Not only did we do crazy things during COVID
    that we shouldn't, we overreacted, but we overspent. Then the
    Fed financed it. That's one of the huge problems of this
    abundant reserve policy, is that the Fed is monetizing our
    debt.
        Chairman Paul. That's a corollary of what Friedman would
    say about spending, that nobody spends somebody else's money as
    wisely. It's the same with borrowing, individual bankers and
    people who will lose their livelihood are going to be wiser,
    not because they are smarter people than the Fed, but because
    they stand to lose more. They have a personal responsibility to
    it. Senator Johnson.
        Dr. Kohn. I think the fact that the Federal spending and
    the money supplied and the QE were correlated were a separate
    response of the Congress and the Federal Reserve to what they
    perceived to be a very serious problem caused by COVID. There
    wasn't a cause and effect.
        I don't think the Trump Biden deficits of 2020, 2021, would
    have been affected if interest rates had been a few basis
    points higher, the Congress would not have passed those bills.
    They are both responding to the same thing. I think you talked,
    Senator Dr. Paul, about sort of the money supply allowing
    inflation. There's some truth there because rather than the
    money supply causing inflation, the Fed supplies the amount of
    money people demand.
        You set an interest rate and you supply the money people
    demand at that interest rate. That's the way monetary policy
    has worked. They demand more in inflation. If you want to stop
    the inflation, set the interest rate higher, they will spend
    less, they will demand less money in those circumstances.
        I do think the stability of our financial markets is really
    important for the inward investment to see the dollar as a
    reserve currency, to see U.S. securities markets as the safest,
    most liquid markets in the world as a very important piece of
    keeping the----
        Chairman Paul. I think what causes inflation is an
    important question. Mr. Wesbury.
        Mr. Wesbury. Yes. OK. The way you described monetary
    policy, that the Feds supplies the money that people demand. I
    would argue that is absolutely true prior to 2008, because what
    abundant reserve policy does is it separates the money supply
    and interest rates. For example, yesterday we saw it that we
    are going to change--we are going to buy $40 billion worth of
    bonds, but we are going to lower the interest rate at the same
    time.
        You did not have to do both or the Fed, you are not the Fed
    anymore, but you represent the Fed. But what we did is we
    completely separated and when we changed from a scarce reserve
    system to an abundant reserve system, we took supply and demand
    out of interest rate markets. The Fed or banks used to trade
    Federal funds every single day. Banks had a Federal funds
    trading desk. The minute we started abundant reserves, all
    those desks are gone.
        There's no more jobs as Federal funds traders because banks
    are overwhelmed with Federal funds. They do not borrow them
    anymore. So you really do not have any way of knowing what the
    demand for money is anymore. It's not related to interest rates
    at all.
        Dr. Kohn. I would say yes, IORB and abundant reserves,
    separated reserves and interest rates. Absolutely. The Fed's
    balance sheet and interest rates are now different--operate on
    different things. That's a feature, not a bug in my view. A bug
    in your view, I get that. But I think the amount of money that
    people outside the Federal Reserve--not talking about banks.
        But people, you and me, Senator Johnson, Dr. Paul demand in
    our bank accounts, it's not really affected by IORB. Well, it's
    affected by the level of interest rates, right? I think it's
    still M2, which is the stuff that people hold is still demand
    determined based on the interest rate. The reserve's part is
    not totally.
        Senator Johnson. Let me try and clarify this by doing what
    I do, problem solving. Let's define the problem we are talking
    about here. I mean, you go back millennia. The Federal Reserve
    is really the culmination of millennia of people trading. You
    used to do barter, that was very efficient.
        So you started creating money, all kinds of different
    things were using trinkets and pebbles and all of a sudden
    precious metals, coins, that type of thing. In order to grow an
    economy, you need to expand the money supply. If you want to
    kill your economy, decrease the supply of money, but it's how
    you manage it. Even though I agree with the gibbons of the
    author of the Creature from Jekyll Island, that the Federal
    Reserve is literally a cartel of these banks, and we have these
    central banks.
        The main task from my standpoint that I believe is they are
    trying to manage that money supply. Try and grow it to
    accommodate a growing economy so we have prosperity. The
    problem is do we do it smartly? I want a quick go to mark to
    market. I am back there in Oshkosh, Wisconsin going, my
    factory's humming along. Why do we have this great recession?
    What caused this? It was stupid regulation.
        You can say these mortgage backed securities was a stupid
    financing tool, but they weren't worth zero, right. But our
    stupid regulation forced banks to write that down to zero and
    we bankrupted banks. But I think in the end, those mortgage
    backed securities were probably worth 80 cents on the dollar.
    Is that about right?
        Mr. Wesbury. Absolutely.
        Senator Johnson. I mean, how stupid is a self-inflicted
    wound? What I am hearing out of this hearing, and I told you
    this, I walked by, said this confuses me. Again, this is
    complex, but I don't think it is. I love Senator Scott. I think
    he's basically getting all concerned about us paying interest
    to foreign banks.
        I mean, foreign banks who buy our treasuries and the
    lawsuit just show up on the Federal Government's balance sheet
    versus the Federal Reserve. I don't think the Federal Reserves
    is all that particularly independent, OK? It's been given a
    task to try and manage our money supply. I think the main issue
    here is the moral hazard.
        By separating supply and demand.
        Mr. Wesbury. Yes.
        Senator Johnson. And by not having those daily markets.
    Again, the beauty of a free market competitive system are
    literally billions of transactions, billions of consumers doing
    all this stuff and just magically works out the pricing. The
    minute you have government starting to do this, you just screw
    things up.
        I would really have to try and understand and nobody does.
    Nobody understands how the Federal Reserve uses this buying and
    selling out to, I just don't get it. But I do get the moral
    hazard of doing this. I have no problem. The banks are going to
    park their money somewhere.
        They are going to get an industry. Either they are going to
    buy the treasuries directly. Foreign banks, same way. Again,
    the problem is our massive debt suspended. It has to be
    financed somehow. We give the Federal Reserve the ability to do
    that. Again, I think it's probably on the margins, because we
    keep industry artificially low, we feel a little bit less
    constrained. If we were paying $2 trillion in interest expense,
    it might.
        I am saying it might cause us to spend less money. I am not
    necessarily sure, I have been trying to get my colleagues to
    spend less money, we all have. Here are three fiscal hawks.
    It's an impossible task. But in my base, it's really the moral
    hazard. Again, Mr. Kohn, you are obviously on different side of
    these.
        Do you acknowledge that is a problem with the Federal
    Reserve doing all this, we do not have all that market, we have
    that disconnect where we are making it easier for Congress to
    spend money. And that's a moral hazard.
        Dr. Kohn. I think it's very small. That is the amount of
    securities that the Fed holds, first of all has gone down by,
    what, about a trillion dollars along with reserves. The
    reserves were over four at one point and now they are around
    three. So that's gone down over the last year. I haven't seen
    any move toward fiscal responsibility.
        Senator Johnson. That's what I was talking about the size
    of the balance sheet, who were $38 trillion in debt. Would we
    have a bigger balance sheet on this side? Again, I just think
    it's a shell game. I just think it's a county convention in
    terms of how we are doing this. The main problem is, again,
    what the Federal Government spends, what we do not take in and
    the difference between that. I just think that is the problem
    that we are simply not cracking.
        Dr. Kohn. It's a huge problem, the trajectory of the
    Federal debt, relative GDP is a big problem.
        Senator Johnson. I am well aware.
        Dr. Kohn. It's a time bomb waiting to go off, but I don't
    think the Fed has caused it.
        Senator Johnson. Let me end on this. The only thing that
    keeps all this thing going is confidence, right? It means it's
    a wonderful life. It's just back then when you didn't have
    reserves and all of a sudden I can't get my money and you get
    to run the bank and nobody had confidence in the system.
        Dr. Kohn. Yes.
        Senator Johnson. Confidence is absolutely critical. That's
    what happened in 2008. We broke the bank and that money market
    fund and confidence just evaporated. I would say the one tool
    that the Federal Reserve provides is just that backstop
    confidence. It's like we will prick the fricking money to make
    sure the defense system doesn't collapse.
        Dr. Kohn. Right.
        Senator Johnson. To have one central bank do that, I think
    that does provide confidence. That's what FDIC insurance is
    for. Again, we see this loan crisis, they increase that too
    much, create a moral hazard. But there's got to be a sweet spot
    that we should have some deposit insurance to provide that
    confidence, but not a dollar more or else you create that moral
    hazard. It's confidence versus moral hazard.
        Dr. Kohn. I think that's why the Fed was created in 1913,
    because there were these periodic losses of confidence. The
    thought was, if you have a discount window, a lending facility,
    and banks can come and take their loans and borrow against them
    and pay out the deposit.
        Senator Johnson. So you have to read Creature from Jekyll
    and then we have to have a conversation. I am not kidding. You
    ought to read that. It's a fascinating book. OK. Then, Mr.
    Wesbury, you had a comment on that.
        Mr. Wesbury. I just wanted to say that in 2008, we had a
    problem, subprime loans. It was a $400, $500 billion problem.
    It was not enough. Even Chairman Greenspan has said or Chairman
    Bernanke said this, it wasn't enough alone to take down the
    U.S. economy. Today, with this new system, this experimental
    system, as Senator Lankford said, the banks plus the Fed have
    over a trillion and a half dollars of losses on their books.
        It's because all these bonds were sold during COVID, during
    2008, at extremely low interest rates. Now, interest rates are
    higher----
        Senator Johnson. But again, we had $38 trillion of losses
    on our books. You add another trillion and a half trillion over
    39 and a half trillion.
        Mr. Wesbury. Yes.
        Senator Johnson. By the way, on the path of about 62
    trillion in 10 years.
        Mr. Wesbury. What I would argue is we have a bigger
    financial problem today than we did back in 2008. It's with all
    of this supposed monetary policy that's made us safer. I would
    argue that we are less safe today as a financial system than we
    were when we started this back in 2008. Thank you.
        Senator Johnson. Again, I want to thank the Chair for
    having this hearing. I want to thank all of you guys. I mean,
    really, this has been a good discussion. This is absolutely
    within this committee's jurisdiction. So I really appreciate
    this.
        Chairman Paul. Senator Scott.
        Senator Scott. Let's go to what Senator Johnson said,
    paying money into foreign banks. Let's say we stopped doing it.
    What would happen? Let's say we stopped, we said we are only
    going to do it to U.S. banks and banks domiciled in the United
    States, headquarters in the United States. What would happen?
        Dr. Kohn. Stop paying interest to the foreign banks. Is
    that what you said?
        Senator Scott. Yes. Stop paying any interest.
        Dr. Kohn. They would get rid of the reserves, right? They
    would sell off the reserves. That would put downward pressure
    on interest rates. The Fed would have to absorb that in order
    to keep interest rates from faling--or the U.S. banks would
    have to end up with the reserves.
        They would have to be induced to take those reserves. So it
    would end up----
        Senator Scott. Why wouldn't they----
        Dr. Kohn. It would tend to pressure interest rates lower at
    a time when inflation is already at three percent. I think that
    would be a problem.
        Senator Scott. If the U.S. banks are going to get paid
    interest on it, why wouldn't they just pick up the slack?
        Dr. Kohn. They already have the reserves they want to hold.
    The Fed could make them, they could have to pick up the slack,
    the Fed determines it. They could pick up the slack and then
    they would have the reserves. But I am not sure what you would
    accomplish that way.
        Senator Scott. It accomplishes the fact that I think the
    Chinese government wants to destroy my way of life and my
    family's way of life. I don't want to give them a dime. I don't
    want Chinese banks to have a dime. If the Chinese government's
    despicable, they are going to take everything they get. They
    are going to build a military to destroy my way of life and my
    kids' way of life.
        Dr. Kohn. I think that's a potential argument. You don't
    want Chinese banks operating in the United States. Then
    somebody, not the Federal Reserve, but somebody needs to pull
    that plug.
        Senator Scott. If the IORB was eliminated, would the banks
    also lend more money to small businesses? My first business was
    a donut shop. I went to the bank, they lent me $7,500. You
    can't get a loan like that from a bank today. I don't know any
    bank that's going to make a loan like that today.
        If we stop paying interest on reserves, would they maybe
    start helping small businesses, which they don't do anymore?
    Any of you?
        Mr. Wesbury. What they would have to do is take whatever
    assets they have, the reserves, they would have to trade them
    for some other asset. They could buy treasury bonds with those
    reserves. They could make loans with those reserves, right. Now
    they are constrained by rule. One of the interesting things is
    that Chairman Powell yesterday said, we are going to start
    buying $40 billion more of treasury bills every month. The
    reason is because there are now pressures in the repo market,
    we can see interest rates starting to act funky and volatile.
        Senator Scott. They have lost control of interest rates.
        Mr. Wesbury. Right.
        Senator Scott. Well, if they're acting funky, that means
    they don't get to dictate exactly the price.
        Mr. Wesbury. That's exactly right.
        Senator Scott. That's why they should be honest. They want
    to control everything.
        Mr. Wesbury. Yes, that's exactly right. But what's
    interesting is the reason we are at that point is because they
    have set regulations so tough on these banks that they are
    forcing them to hold this amount of reserves. Then they brought
    the reserves down right to that level.
        And they go, ``Oh, no. Now we have to increase them.'' They
    could easily reduce the liquidity rules. If they did that, more
    loans would go to small businesses.
        Senator Scott. Because you can make a profit off it.
        Mr. Wesbury. Yes. Exactly.
        Senator Scott. What they are doing is impacting small
    business ability to get a loan?
        Mr. Wesbury. Absolutely. They are forcing banks to hold
    reserves instead of make loans or buy treasury bonds.
        Senator Scott. My State who's getting hurt are the poorest
    families that don't have the relationships to go get a loan.
    Like I had no relationships to go get the $7,500 when I got out
    of the Navy to buy a donut shop.
        If the bank hadn't lent me money, I don't know how it would
    have gotten started. I had no relative, I knew that had a
    thousand bucks.
        Mr. Wesbury. Yes.
        Senator Scott. What they are doing is they are making it
    harder for small businesses to get started. It hurts the
    poorest families in this country.
        Mr. Wesbury. Exactly.
        Dr. Kohn. That's a product of the regulation, not of the
    interest by Federal Reserve. All the other regulators trying to
    keep these banks safe. Now, you could argue that they went too
    far after 2008. That's what the administration is arguing and
    they are pulling the regulations back.
        We will see whether that happens. But it's not the reserve
    balances. What would happen when the Fed sold the securities
    that created the reserve balances in your world in which the
    balances went down, they would extinguish deposits. They sell
    me a security, they get my check, they clear it against my
    bank, right. The bank doesn't have--just because the reserves
    go down doesn't mean it has more money to make loans. It just
    has fewer deposits. The reserves and the deposits will go down
    together.
        Senator Scott. But they have an incentive to make a loan
    because there would be more money.
        Dr. Kohn. But they also have more trouble managing the
    liquidity. This is a problem for smaller banks.
        Senator Scott. I mean, the way I look at it is, what we
    have done is we have created all these rules and regulations so
    the banks can't even do what they are expected to do. Lend me
    money so I can start my little business. They are not doing
    that today. Your consumer credit is a interest rate of 20
    percent plus from the credit card.
        That's the only place you can get it. I think Dr. Kohn, you
    said that, they did not have an impact on interest rates. If
    the Federal Reserve had not been buying 40 plus percent of the
    treasuries during the Biden term, right? You think interest
    rates would have stayed the same?
        Dr. Kohn. No, I think the treasury rates would have been a
    bit higher and mortgage rates would have been a bit higher, and
    rates on auto loans would have been a bit higher, and there
    would be less spending on houses, autos, and the recession
    would have been deeper.
        Senator Scott. OK. All we did is we decided when we do
    that, so now what's happening, like in my State, is the
    interest rates are not coming down. Long-term rates are not
    coming down, then the value of homes are coming down. So, what
    they did is they caused a significant asset bubble,
        Dr. Kohn. But that's not under the control. You said the
    Fed wants to control everything. What they want to control are
    the rates at the very short end of the market, the repo rates--
    --
        Senator Scott. That's not what they bought. They bought
    long term, but now they are getting rid of them, right?
        Dr. Kohn. Yes.
        Senator Scott. They bought long term.
        Dr. Kohn. Yes. In order to keep those rates down, they
    stopped doing it. They were until December 1st, reducing the
    amount of securities.
        Senator Scott. They caused this ridiculous bubble. Now
    what's happening in my State, people are getting their butts
    kicked. They bought a house, right? They bought a house and now
    the prices of the house is coming down because interest rates
    are not coming down.
        It hurts the poor. Again, it's always the poorest families
    that get hurt. The rich have plenty of cash. They can't do it.
    The people are leveraged to the hilt. They are getting their
    butts kicked. It's so frustrated. They cause these bubbles.
    Then the poorest people are the one that get hurt.
        Chairman Paul. Thank you. One of the points that Dr. Kohn
    made is that the Fed tries to accommodate the public's demand
    for money. I guess I would argue that particularly in the
    subprime loan crisis, that it was made worse by the Fed
    creating interest rates below the market rate. In a real
    economy where the interest rates, because they are set by a
    vote.
        We do not set the price of bread by a vote. This isn't a
    real good, real market pricing system. A bunch of old guys at
    the Fed vote on what the price of money should be. But in a
    real economy that has freely floating interest rates, if you
    have a housing boom and everybody wants to borrow money, you
    have increased demand for the money, the response would be the
    interest rates would rise.
        But you had a period of time from like 2000 to 2007 where
    you got interest rates are like two, which is essentially zero.
    If you got inflation of two or three, and you got interest
    rates of two, your real interest rates is like zero. That's not
    a real interest rate. I don't think the market would do that.
        As you have this housing boom, interest rates would have
    risen. The cycle of the economy is incredibly dependent on
    interest rates to tamponade the effect of the boom. As you get
    a boom, as interest rates go up, only the better projects, the
    ones more likely to succeed will happen. If I am borrowing
    something with no capital and stuff, like I am falling away as
    interest rates go up.
        But if you don't allow that, you are part of what creates
    the boom, the Federal Reserve was responsible in some way for
    the boom by keeping interest rates below the market rate. I am
    not going to start with you, but I will come back to you. Let's
    start with Dr. Michel. What do you think of what I said?
        Dr. Michel. It definitely has an effect on rates. It's
    probably not positive in the sense that it's not a good
    outcome. But I also think it's very important that we don't
    divorce what the Fed's doing in that regard from what the rest
    of the Federal Government is doing. The Fed didn't decide to
    create tarp. So, there's a lot of money floating around and any
    of the money that they did provide for liquidity could have
    been provided through Congress. A lot of it was done in both
    places. I think it's hard to separate out----
        Chairman Paul. The low interest rates leading up to it also
    have a reason. I think, one, they may say they want to help the
    economy, but they are really trying to keep the financing of a
    $38 trillion debt manageable. That's a big reason for why we
    will----
        Dr. Michel. Also combined. Yes.
        Chairman Paul. Yes.
        Dr. Michel. Yes.
        Chairman Paul. Ryan?
        Mr. Young. Yes, it's a question of tradeoffs. If you lower
    interest rates, yes, you lower the price of government debt and
    that can be very important for the Federal Government's fiscal
    health. But the tradeoff of that is higher inflation for the
    rest of us. So you can choose one policy or the other, but you
    can't choose both because there will always be a tradeoff.
        Chairman Paul. Mr. Wesbury.
        Mr. Wesbury. Yes. Bubbles as well. I mean, Ryan, you are
    absolutely right. The interesting thing today is pre-2008, we
    had a scarce reserve system and banks traded reserves, every
    single day there was a marketplace. Once we have made abundant
    reserves, nobody trades Federal funds. There is no market rate
    anymore. Dr. Paul, you are absolutely right. They sit around a
    table and they go, what do you think? Three and a quarter?
    Three and a half----
        Chairman Paul. But I guess my response to that is between
    2000 and 2007, we were still doing, as you say, having this
    daily marketplace. I would still argue that from 2000 and 2007,
    that the interest rates were at the direction of the Fed below
    the market.
        Mr. Wesbury. I agree. Because they were adding reserves
    that they shouldn't have added. It can happen under either
    system. It can totally happen. But today there is no market
    input at all. That's what I would argue. That the Fed cannot
    see the demand for money, when the rate would want to go up
    under the old system, that was a demand for money. Today there
    is no sign of demand for money like that.
        Chairman Paul. I think we have pretty good focusing of this
    debate. Is this debate going on outside this room?
        Mr. Wesbury. I wish it was going on more. One of the things
    I will say is that you and your staff study, which is
    fantastic. For the first time that I know of forced Chairman
    Powell to address the ample abundant reserve issues in a speech
    because the Federal Reserve has kind of ignored, acted as if it
    doesn't really exist and the press doesn't ask questions. Thank
    you for pushing this.
        Chairman Paul. I think the point that we have gotten to is
    a better and more important point about whether the treasury
    loses money, the profit loss of the Fed. We are talking about
    whether or not the interest rates are being set by a daily
    marketplace versus a long-term thing, which seems to be more of
    a decision by fiat, a decision by a bunch of, let's just call
    them grumpy old man around the table.
        Mr. Wesbury. I call it brace fixing.
        Dr. Kohn. I don't think there's any difference between the
    way rates basically were set before 2008, and I was part of
    this back into the 1970s when I joined the Federal Reserve.
    Every day we had a call with the Federal Reserve Bank in New
    York and the board staff decided how much money they needed to
    put in or take out in order to fix the interest rate, right?
        The mechanism was a little different under scarce reserves.
    But the control of the Federal funds rate of the short-term
    interest rates, the repo rates, were just as strict before 2008
    as after 2008.
        Chairman Paul. I would argue that one of the things that
    brought down the Soviet Union is that nobody knew the correct
    price of bread because the marketplace doesn't work because
    nobody does. I set it here and then I have bread rotting on the
    shelves. I set it too low, all the bread's gone.
        The only thing that can figure out, and this is the miracle
    of capitalism, is that supply and demand, and as Senator
    Johnson, millions and billions of people trading
    instantaneously leads to justice, this incredible knowledge
    that no one possesses, right? It was this whole idea that Hayak
    talked about. The conceit of a bunch of 10 really smart men. I
    am not begrudging the people of the Fed not being smart.
        They probably are very smart, but they are not as smart as
    a million people in the marketplace. What we should try to do
    is have as little impact from the Fed on what interest rates
    are and figure out a way if there is a transition to a more
    market oriented where most of the interest rate is determined
    by the market because I think between 2000 and 2007 under the
    old system, they were manipulating it.
        I think it caused the subprime crisis. I agree mark to
    market probably exponentially made the subprime crisis work,
    but it got started with the subprime crisis, which I think is
    directly related to interest rates being lower than what the
    market would have dictate----
        Dr. Kohn. I mean, the market controls every interest rate
    beyond the overnight interest rate. If the market thought what
    the Fed was doing was right now, lowering rates was
    inflationary, you would see it in the bond market and you don't
    see it.
        Chairman Paul. Then they also control the money supply.
    Don't you think the money supply has something to do with
    interest rates also?
        Dr. Kohn. I think it's the amount of money, the M2 money
    supply, the amount of money people want to hold at the current
    interest rate. Yes.
        Mr. Wesbury. I would argue the Fed influences interest
    rates out the yield curve too. That's what the whole idea of
    forward guidance is. I do not mean to take us off this path,
    but they have tried to influence long-term rates with forward
    guidance and by buying different parts of the yield curve----
        Dr. Kohn. In these zero interest rate situations----
        Mr. Wesbury. Under the old system, they certainly could
    hold interest rates lower than they should. And they did. They,
    in fact, they helped cause the housing bubble. The interesting
    thing is, in that system at least there was some market input,
    Federal funds trading desk giving a signal.
        Under this current system, there is no market input. As a
    result, I think it's even moving back a step to that scarce
    reserve system would be a step forward. Then we can talk about
    moving forward.
        Chairman Paul. Dr. Kohn, are you familiar with the Austrian
    understanding of the business cycle and explanation of the
    business cycle? Do you accept the idea?
        Dr. Kohn. A little bit.
        Chairman Paul. The ideas were basically that inflation and
    the effects of expanding credit hit different segments of the
    economy at different times. They lead to misinformation. They
    lead to a theory that you believe you are better off than you
    actually are. And so capital goods makes a decision. Consumers
    make a decision. There's a time lag between these two.
        By the time it catches up and the consumers say, ``Oh gosh,
    we have three times as much money.'' It's worth a third less
    the capital goods people are still making stuff. Then that
    differential and that separation is what causes it. That it
    isn't like on TV, it's presented as `Well, gosh darn it, we
    just don't know what causes inflation and we don't know what
    causes it. It's just a mystery what causes the business
    cycle.'' I think it was actually explained pretty well by the
    Austrians.
        Dr. Kohn. Yes. I think I agree that expectations are very
    important for how people spend and they form their expectations
    by looking around them. I also agree that people tend to get
    very optimistic in the up parts of the cycle and very
    pessimistic in the down parts. That's consistent with the story
    they are telling.
        Chairman Paul. The key fact is that counteracts either
    irrational exuberance or any of that is the interest rate. If
    the interest rate doesn't rise, it's the one price that is
    universally throughout the economy. It's the one thing that
    will slow an economy down that is going too rapid. By too
    rapid, I don't know that it just there is a point at which the
    economy is growing so rapidly that you feel you are in a
    bubble.
        It's not my job to figure that out or to tell the economy
    to stop. But as interest rates rise, less things will be
    financed. There will be less loans.
        Dr. Kohn. There was very little inflation in 2006 and 2007.
    I was voting on interest rates in 2006 and 2007, and we did
    raise rates for a while up to around five percent, I think. So
    not two percent, but more like five percent. So the real rates
    were positive.
        There was an argument, and I have had this discussion with
    John Taylor for example, that the Fed should have raised rates
    a little more because the inflation threat was higher. I think
    the problem was regulation. There was too much deregulation,
    there was too much reliance on the private sector to make
    decisions and without constraint, and without recognizing the
    knock-on effects, the externalities economists call them of the
    decisions they were making.
        And risk built up in this euphoria to your point about
    cycles. Then when it collapsed, it really collapsed. You are
    right. It was a loss of confidence that really caused the
    financial crisis in 2008. The losses were there.
        Chairman Paul. Thank you.
        Senator Johnson. I just have one question. It does relate
    with markets setting interest rates. My stance, is there's two
    problems. I just wanted to ask whether they ever consider the
    other problem. Obviously interest rates too high, it constricts
    economic growth. Too low, it could maybe lead to exuberance. Is
    there ever a consideration of the misallocation of capital
    within that?
        In terms of where capital actually flows, first of all,
    just in terms of far riskier assets, which can misallocate
    capital, is that ever part of the equation? Or is it simply
    just, is the economy going to heat up? It's going to slow down?
        Dr. Kohn. That's part of the discussion, but the Fed really
    has one instrument. Let's forget the QE period. Under 95
    percent of the time, the Fed is trying to balance the economy
    using the short-term interest rate and giving them another
    target telling them that maybe a problem.
        Senator Johnson. Yes, I am not asking them to manage. I
    mean, is that a consideration? Have anybody looked back for the
    last 25 years and go, man, we really misallocated capital. We
    had too many things flow into this sector of economy because we
    kept interest rates artificially wrong. It was just free money.
    Or am I just off base here?
        Mr. Wesbury. It happened in the housing bubble in 2005,
    2006, 2007, and I would argue we have misallocated capital
    toward government with these zero percent interest rates in
    nine out of the last 15 years. When you have zero percent
    interest rates, it's pretty easy to finance government and make
    it seem cheaper.
        Senator Johnson. It's been more than nine out of the last
    15 years.
        Mr. Wesbury. Yes. But I mean zero. They had zero.
        Senator Johnson. I am getting this misallocation to the
    government.
        Mr. Wesbury. By the way, it's one of the arguments that I
    would use about getting rid of interest on reserve balances.
    The Fed did hold interest rates basically at zero for nine
    years. That was OK by them. Now when we want to get rid of
    interest on reserve balances, they go, ``Well, you can't force
    us to hold them at zero. We can only hold them at zero when we
    want to.''
        And so, I would argue that's not a really good argument to
    make.
        Senator Johnson. By the way, you are right, the primary
    misallocation was to government.
        Mr. Wesbury. Yes. It was also the houses and other things.
    But the Austrian business cycle is a fabulous thing. That
    misallocation of resources happens when you hold interest rates
    too low.
        Chairman Paul. I think this has been my favorite hearing of
    the whole year. Even though the minority says it wasn't under
    our jurisdiction, the one prerogative of the chairman is I get
    to decide what is under my jurisdiction. We were not creating
    law today, but I think we had a very helpful discussion.
        We had viewpoints, I think, across the spectrum. I think it
    was very good. I hope we will pursue this. To each of the
    participants, Republican and Democrat, I am happy to hear from
    you anytime. If you have advice, something you have written and
    you want to send it to us, I don't claim to know everything
    about it.
        I mean this much and like the subject and want to know
    more. But I would claim a lot of other people are in the same
    boat, not necessarily that there is some committee that knows
    more than the rest of us.
        But thank you all for coming. The record for this hearing
    will remain open until 5 p.m. on Friday, December 12, 2025, for
    the submission of statements and questions for the record. The
    hearing is now adjourned. Thank you.
        [Whereupon, at 11:47 a.m., the hearing was adjourned.]

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