During the 2008 financial crisis, Congress changed the start date for paying interest on bank reserves held at the Federal Reserve. The Emergency Economic Stabilization Act amended earlier law so the Fed could begin paying interest on reserves starting October 1, 2008. This created a new tool for controlling short-term interest rates even as reserves in the banking system were rising.
The Federal Reserve announced it would start paying interest on required and excess reserve balances held by depository institutions. Paying interest on reserves (often shortened to IOR) gave the Fed a way to influence banks’ willingness to hold reserves rather than lend them overnight. The rule changes took effect on October 9, 2008.
The Federal Reserve announced it would purchase up to $100 billion in agency debt and up to $500 billion in agency mortgage-backed securities (MBS). These purchases aimed to lower mortgage rates and improve market functioning, expanding the Fed’s balance sheet significantly. IOR helped the Fed manage the resulting surge in reserve balances without losing control of short-term rates.
With financial conditions deteriorating, the FOMC shifted from a single federal funds rate target to a target range of 0 to 1/4 percent. This change reflected the limits of cutting rates further near zero and pushed the Fed toward heavier use of balance-sheet tools. It also increased the importance of IOR for keeping market rates from falling too far below the desired range.
As the recession deepened, the FOMC expanded its planned purchases of agency MBS and agency debt and added purchases of longer-term Treasury securities. This marked a major step toward using the Fed’s asset holdings as an active policy tool, not just a byproduct of crisis lending. The growth in reserves reinforced the shift toward an operating approach where administered rates like IOR could act as a floor for money-market rates.
When principal payments on agency debt and agency MBS began to reduce the Fed’s securities holdings, the FOMC directed the New York Fed’s trading desk to reinvest those principal payments into longer-term Treasury securities. This decision helped keep the balance sheet roughly steady rather than allowing a passive tightening. It also supported the “ample reserves” environment in which IOR could remain central to rate control.
The FOMC directed the New York Fed to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011. This second round of large-scale asset purchases (often called QE2) sought to provide additional monetary accommodation after the recovery remained weak. It further entrenched a policy setting where large reserve balances were normal and IOR helped support a floor under short-term rates.
The FOMC directed the desk to buy $400 billion of longer-maturity Treasury securities and sell an equal amount of shorter-maturity Treasuries by the end of June 2012, aiming to push down longer-term rates without expanding the balance sheet. At the same time, the Fed shifted reinvestment of principal payments from agency debt and MBS into agency MBS. This increased the Fed’s exposure to mortgage markets while still relying on IOR to manage short-term rate control amid high reserves.
The FOMC announced it would purchase additional agency MBS at a pace of $40 billion per month. Unlike earlier programs with fixed totals, this approach was designed to continue until there was substantial improvement in the labor market outlook. The policy relied on an expanded balance sheet and abundant reserves, with IOR remaining a key administered rate supporting the floor-style operating system.
After the maturity extension program ended, the FOMC directed the New York Fed to purchase longer-term Treasury securities at about $45 billion per month while continuing $40 billion per month of agency MBS purchases. Together, these purchases kept total monthly buying at roughly $85 billion and continued to expand the Fed’s balance sheet. With reserves growing, IOR and related tools became central to implementing the desired policy stance at near-zero short-term rates.
The FOMC decided to reduce the pace of its asset purchases, starting with a cut to $75 billion per month beginning in January 2014. The move reflected improved economic conditions and marked the start of a gradual transition away from expanding the balance sheet. Even with tapering, the Fed continued to rely on IOR within an ample-reserves framework to keep short-term rates aligned with policy intentions.
The FOMC concluded its asset purchase program as labor market conditions improved, ending the regular expansion of its securities holdings. However, it maintained the policy of reinvesting principal payments from agency debt and agency MBS into agency MBS and rolling over maturing Treasuries at auction. This kept the balance sheet large and reserves abundant, reinforcing IOR’s role in a floor-style operating framework.
The FOMC raised the federal funds rate target range to 1/4 to 1/2 percent, the first increase since 2006, effective December 17, 2015. The Fed implemented the increase in an ample-reserves environment using administered rates, including raising the interest rate paid on required and excess reserve balances. This highlighted how the post-2008 floor system supported rate increases without first shrinking the balance sheet.
The FOMC published an addendum describing how it intended to reduce securities holdings by scaling back reinvestments using gradually rising monthly caps. The plan set separate cap paths for Treasury principal payments and for agency debt and MBS principal payments. This made balance sheet reduction more predictable and linked it to a policy framework where the fed funds rate (supported by tools like IOR) remained the primary policy lever.
The FOMC announced it would start the balance sheet normalization program in October 2017, reducing holdings by reinvesting principal payments only above the stated caps. This marked the transition from holding the balance sheet steady (through reinvestment) to allowing a gradual decline in securities holdings. The approach aimed to shrink the balance sheet while continuing to implement monetary policy in an ample-reserves, floor-system environment.
By early 2018, the Fed’s runoff program was operating as designed: principal payments were reinvested only above the monthly caps, allowing securities holdings to decline gradually. Analysts emphasized that agency MBS holdings would likely decline more unevenly than Treasuries because mortgage prepayments vary with interest rates and refinancing activity. This period marked the “steady-state” phase of the 2017–2018 normalization design, combining a large but shrinking balance sheet with floor-style rate control centered on interest paid on reserves.
Interest on reserves, floor system adoption, and balance sheet policy (2008-2018)