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39 Cato J. 327 (2019)
Interest on Reserves: History and Rationale, Complications and Risks

handle is hein.journals/catoj39 and id is 334 raw text is: INTEREST ON RESERVES: HISTORY AND RATIONALE, COMPLICATIONS AND RISKS Peter N. Ireland Among the enduring legacies of the 2007-09 financial crisis, inter- est on excess reserves (IOER) now plays a central role in the Federal Reserve's policymaking framework. Famous arguments justify pay- ing interest on required (but not excess) reserves on economic effi- ciency grounds. However, the Fed has used its power to pay IOER to facilitate credit market interventions that extend well beyond those required by its traditional central banking fimctions-namely, con- ducting monetary policy to stabilize the aggregate nominal price level and acting as a lender of last resort to illiquid but solvent depository institutions. One must question the wisdom of making IOER a per- manent part of the Fed's toolkit, given the resulting complications and risks. History and Rationale George Tolley (1957) and Milton Friedman (1960) first argued that since bank reserves can be created at zero marginal cost within a fiat money regime, economic efficiency dictates that the opportu- nity cost to banks of holding reserves should be driven to zero as well. Tolley and Friedman also pointed out that one way to satisfy this effi- ciency condition is for the central bank to pay interest on required Cato Jounal, Vol. 39, No. 2 (Spring/Summer 2019). Copyright © Cato Institute. All rights reserved. Peter N. Ireland is the Murray and Monti Professor of Economics at Boston College and a member of the Shadow Open Market Committee. He thanks David Andolfatto for helpful comments on an earlier version of this article. The usual caveat applies.