Why IOER Matters to You

IOER, or “Interest On Excess Reserves,” refers to the interest the Fed and other central banks pay banks on their excess money (reserves) they keep in those central banks.  So, if I’m a large bank, and I deposit more money than is required at any Fed bank, I get paid 25 basis points on that money.  As of the latest Fed release, in October there was more than $2 trillion in “excess reserves” on the Fed’s balance sheet, earning 0.25% annual interest.

One of the big problems the Fed, and other central banks, has is getting money off the banks’ balance sheets and into the “real economy” via lending.  Well, one of the theoretical ways to “force” banks to lend money would be for the Fed to push the IOER negative.  So, instead of the banks earning 0.25% annually on the $2 trillion at the Fed, they would have to start paying interest on those balances, which theoretically should compel them to lend the money out.

This is important because a negative IOER is one of the few remaining “bullets” the Fed has in its arsenal to help stimulate the economy.  And, while it becoming reality is likely still a long shot here in the U.S. or in Europe, a negative IOER would be, theoretically, an economically stimulating move by the Fed or ECB (so, dovish and likely equity-positive). I wanted to make sure everyone knew exactly what it was, because it’s a topic I think will come up a lot more in the coming weeks/months, and it will be a focus of markets at tomorrow’s ECB meeting and Fed meeting later this month.