Question

Why is paying interests on reserves an important tool for the defeated federal reserve in managing crises

Answer 1

During crisis period, liquidity becomes a major issue and maintaining an adequate liquidity for Banks and financial institutions becomes very crucial. However, if this liquidity is flowed-in with no cost, it is very likely to drag the Fed fund rates down. Therefore, there exists a need of cost for this liquidity infusion. This is where interest on reserves comes in picture as this enables Fed to infuse actual required levels of liquidity without impacting its fund rates.