Interest on Reserve Balances (IORB)
What is Interest on Reserve Balances (IORB)?
Interest on reserve balances (IORB) is the rate the Fed pays banks on reserves held at the Fed; it is now the Fed's main tool for steering the federal funds rate.
Since 2008 the Fed pays interest on reserves, and since 2021 a single IORB rate replaced the separate IORR/IOER rates. Banks will not lend in the fed funds market below what they can earn risk-free at the Fed, so IORB sets a floor that anchors short-term rates in today's ample-reserves system. Raising IORB tightens policy; lowering it eases.
Interest on Reserve Balances (IORB): a worked example
A bank holds $4 billion in reserve balances at the Fed, and the Fed sets IORB at 4.4%. Leaving those funds parked earns $4 billion × 0.044 = $176 million over a year with no credit risk and no effort. Another bank offers to borrow the same funds in the federal funds market at 4.2%, which would return $4 billion × 0.042 = $168 million, or $8 million less, and would carry counterparty risk on top. The first bank refuses, and so does every other bank facing the same arithmetic, which is why the federal funds rate cannot settle far below 4.4%. Now let the Fed raise IORB to 4.9%. The floor rises with it, the federal funds rate follows, and short-term borrowing costs across the economy tighten.
The mistake students make with interest on reserve balances (iorb)
IORB gets mixed up with the discount rate, since both are central bank rates attached to reserves, and students write that banks pay IORB to borrow from the Fed. The two run in opposite directions. The Fed pays IORB to banks on balances they already hold there, making it income on a bank asset. Banks pay the discount rate to the Fed to borrow at the discount window, making it a cost. Placed against the target range, the discount rate sits above it as a ceiling while IORB sits near the bottom as a floor.
Interest on Reserve Balances (IORB) questions
How does IORB set a floor under the federal funds rate?
No bank will lend reserves to another bank below what the Fed pays it risk free on the very same funds. IORB therefore acts as a reservation price: when the federal funds rate drifts below IORB, banks pull back from lending and park reserves instead, and the shrinking supply of funds pushes the rate back up. Because reserves are ample rather than scarce, that floor, not a shortage of reserves, is what anchors overnight rates inside the Fed's target range.
What is the difference between IORB and a reserve requirement?
IORB is a price and a reserve requirement is a quantity rule. IORB pays banks a rate on the balances they keep at the central bank, which changes how attractive holding reserves is at the margin without forbidding anything. A reserve requirement instead orders banks to hold at least a set fraction of deposits as reserves, which caps how far deposits can multiply. Under ample reserves banks hold far more than any requirement would compel, so the requirement stops binding and the administered rate does the steering.
How does raising IORB tighten the economy?
Raising IORB raises the return banks earn for doing nothing with their reserves, so the bar a new loan must clear rises with it. Banks lend less freely, the federal funds rate and other short-term rates get pulled up behind the higher floor, borrowing costs for firms and households climb, and interest sensitive spending on investment and durable goods falls. Aggregate demand shifts left and pressure on the price level eases. Lowering IORB runs the same chain in the opposite direction.
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