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Windfall for Taxpayers Coming to an End

WASHINGTON — The Federal Reserve’s bond-buying campaign continues to produce one clear benefit: a windfall for taxpayers.

The Fed, which turns over most of its profits to the Treasury Department, said on Friday that last year, it transferred an estimated $98.7 billion, a record. The Fed’s profits have been large enough to significantly restrain the growth of the federal debt, cutting aggregate deficits by about 8 percent since 2010.

But the good times are drawing to a close. The Fed’s earnings will decrease as it raises its benchmark interest rate, a process that Fed officials say they are likely to begin later this year. The Congressional Budget Office estimated last year that the Fed’s annual transfers could reach a low point of just $8 billion in 2018.

The Fed did not buy the bonds to make money. It has amassed more than $4 trillion in Treasury and mortgage-backed securities in an effort to stimulate economic growth by holding down borrowing costs for businesses and consumers. The Fed says the campaign has helped people buy cars and refinance mortgages. Some independent experts, however, see scant evidence of an economic lift.

The purchases are undoubtedly lucrative, in large part because the Fed pays for the bonds with money that it creates, rather like a restaurant with the unusual power to create hamburgers from nothing. As a result, the interest payments on those bonds are very nearly pure profit, which the central bank is required by law to remit to the Treasury Department after subtracting its operating expenses.

The Fed has sent Treasury $421 billion over the last five years.

The Fed’s portfolio consists of government debt — Treasury securities and mortgage bonds issued by Fannie Mae and Freddie Mac — so the Fed is effectively refunding interest payments, reducing federal borrowing costs.

Over the next several years, the Fed’s expenses are likely to rise.

Last year, the Fed spent about $4.9 billion on its own operations and provided $563 million in funding for the Consumer Financial Protection Bureau, which assumed some of the Fed’s regulatory responsibilities after the financial crisis.

The Fed also paid banks about $6.9 billion in interest on deposits they keep with the central bank. And as the Fed retreats from its stimulus campaign by raising its benchmark interest rates, it plans to sharply increase those payments.

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Richard Fisher of the Federal Reserve Bank of Dallas. Credit...Andrew D. Brosig/The Daily Sentinel, via Associated Press

Banks must maintain reserve accounts with the Fed in proportion to their outstanding loans and other assets, but they earn interest on any excess. Those excess reserves have ballooned as the Fed has bought bonds from the banks because the Fed’s payments have significantly outpaced lending growth.

As it begins to raise its benchmark interest rate, the Fed plans to increase those payments as a check on lending growth. When a bank makes a loan, some of its excess reserves become mandatory reserves, reducing revenue. So banks will make loans only if the likely return exceeds the lost income from the Fed.

In effect, the Fed plans to build a dam between the money that it has created to buy bonds and the rest of the money that circulates through the economy.

Fed officials have repeatedly expressed confidence that the dam will hold, but the strategy is untested — Congress only granted the Fed authority to pay interest on excess reserves in 2008 — and some critics see a danger of flooding. They warn that the Fed may fail to check loan growth, leading to runaway inflation.

“As the economy grows, the massive amount of money sitting on the sidelines will be activated; the velocity of money will accelerate,” Richard Fisher, president of the Federal Reserve Bank of Dallas, said in a speech last year. “If it does so too quickly, we might create inflation or financial market instability or both.”

Comparing the Fed’s challenge to the proverbial difficulty of passing a camel through the eye of a needle, Mr. Fisher said, “The eye of the needle of pulling off a clean exit is narrow; the camel is already too fat.”

Paying banks billions of dollars not to make loans also may expose the Fed to sharp political criticism, particularly because foreign banks hold a large share of the excess reserves and thus stand to receive much of the payments.

Foreign banks like Deutsche Bank, UBS and the Bank of China held about 43 percent of excess reserves at the end of 2013, according to a report last year by the Bank for International Settlements, the central bank for central banks.

The Fed has said the decline in profits could be large enough in the coming years that it might not be able to transfer any money for the first time since 1934.

Marvin Goodfriend, a professor of economics at Carnegie Mellon University, contended in a paper last year that the Fed should retain some of its current earnings as a reserve against the possibility of losses. Fed officials have adopted a cosmetic version of that strategy, emphasizing in public remarks that lower profits or even losses should be seen in the context of the present windfall.

A version of this article appears in print on  , Section B, Page 1 of the New York edition with the headline: End Coming to Windfall for Taxpayers. Order Reprints | Today’s Paper | Subscribe

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