As the Trump economic revival doubled economic-growth rates over the last two years, interest rates, which had fallen in the final two years of the Obama era, have risen by more than 40%. Today no news cycle is complete without speculation about how much the Federal Reserve will raise interest rates or how the president has blasted the Fed for setting rates too high. The latest saga played out last month, with the Fed raising rates for the fourth time in 2018 even though market rates were down slightly since the last Fed hike, in September. Extraordinarily, this debate is occurring at the very moment the Fed—shackled by its bloated asset holdings and the resulting excess reserves of the banking system—has less ability to control interest rates than it has had in its entire 105-year history.

When the subprime crisis caused financial markets to freeze up in 2008, the Fed responded by pumping liquidity into the banking system. It also did something that was not widely discussed at the time and even a decade later is almost never taken into account: It started to pay interest on reserves, in essence paying banks not to lend. This effectively converted the reserves of the banking system into interest-bearing securities.

When the recovery lagged, the Fed continued its monetary expansion by increasing the assets in its balance sheet to almost five times their prerecession level. By buying Treasurys and mortgage-backed securities, the Fed acquired or offset some 45% of all federal debt issued during the Obama era—about four times the share of federal debt the Fed purchased during World War II. But whereas Fed purchases during World War II expanded bank reserves, bank lending and the money supply, the much larger debt purchases of the Obama era did not significantly increase bank lending or the money supply. The increase in bank reserves, which grew as a mirror image of Fed asset purchases, was sterilized by the policy of paying interest on reserves, which induced banks to hold them as income-yielding assets.

In August 2008, banks held a total of 14 cents of reserves for every dollar of demand deposits outstanding, reflecting a normal reserve ratio in a fractional-reserve banking system. Today, U.S. banks hold $1.31 of reserves for every dollar of demand deposits outstanding.

From 2009-16, private loan demand was weak in an economy kept in a stupor by high taxes and an avalanche of regulations. In that stagnant environment, the Fed was able to manage its massive balance sheet and inflated bank reserves without either igniting inflation or causing interest rates to rise. But the strong growth of the past 18 months is now driving up the demand for bank loans, increasing interest rates, and in the process incentivizing banks to lend.