Because domestic depository institutions can receive IOER and the effective federal funds rate is below the IOER rate, they have largely ceased lending in the overnight market.
One explanation for this is that the domestic banks have moved out of the business of arbitraging the difference between the federal funds rate and the IOER rate.
When a target rate increase is announced, is it accompanied by an increase in the IOER rate?
Alternatively, the Fed could raise the IOER rate to enhance the real demand for reserve balances.
In any case, even in a liquidity trap the theory presented here shows how the Fed's IOER rate can be used to blunt undue price-level pressure.
In the event that the federal funds rate does not respond as desired, the Fed is likely to increase the IOER rate in its attempt to maintain monetary policy control.
In 2010, it began testing its Term Deposit Facility, whereby the Fed borrows back reserve money from commercial banks for 21 days, paying the IOER rate plus 3 basis points.
The Fed's "liabilities" never have to be repaid in something it can't create ad lib, and even the interest rate it pays on reserves is discretionary and could be cut to zero tomorrow (although, to be sure, the Fed does not want to cut the IOER rate given the inflationary consequences).
The combination of QE + IOER, not a monetary policy, is best understood as a preferential credit allocation policy.
Despite an extremely large quantity of reserves outstanding overnight since the financial crisis, the federal funds rate has not been pegged by the IOER (Figure 6).
While the IOER should effectively determine the federal funds rate, it has already been shown that this has not happened (see Figure 6).
If the economy accelerates and inflationary pressures emerge, one might expect the FOMC to change its post-meeting statement language to prepare markets for an anticipated increase in IOER