Now for a more subtle point. The interest rate on excess reservesplays a supporting role to the fed funds rate in monetary policy. Previously, the Fed set the interest rate on excess reserves at the same level as the top of the- fed funds rate. But on Wednesday the Fed said the interest rate on excess reserves would now be set 0.05 percentage point below the top of the range.

As a result, the interest rate on excess reserves is now 1.95 percent.

Why the interest rate on excess reserves exists

After the financial crisis of 2008, the Fed wanted interest rates to stay low and for banks to keep lending. To do that, the Fed effectively printed money and used it to buy trillions of dollars worth of bonds. Banks turned around and deposited much of that money back at the Fed. Banks’ deposits at the Fed are called reserves, and before the crisis banks would try and keep a bare minimum at the central bank. But because the Fed’s bond-buying program pumped so much money into the financial system, banks had huge amounts of “excess” reserves. Today, those reserves total $1.89 trillion.

So, why would the Fed pay interest on these excess reserves? The rate was introduced to give the Fed control over the reserves. Banks can turn reserves into real money by making loans. If banks make too many loans, the economy could overheat. To guard against that, the Fed introduced the excess reserve rate. If the economy is growing too quickly, the Fed can raise the interest rate on excess reserves to persuade banks to keep money at the Fed, rather than deploying it in the economy.

Why was the rate changed?

Right now, the Fed doesn’t need to use the rate on excess reserves as an emergency brake. But the rate does play a role in the Fed’s monetary policy.

Start with the overnight market, in which banks borrow money from other financial institutions, known as the fed funds market. Here, banks borrow money, paying an interest rate that is within the Fed’s targeted range for the federal funds rate. The banks may then deposit that money at the Fed, where it will earn the interest rate on excess reserves that is a tiny bit higher than the fed funds rate at which they borrowed.