by

Robert Cauneau

30 June 2025

---

Abstract

From an obscure monetary plumbing mechanism to a massive transfer of hundreds of billions of euros and dollars, the remuneration of bank reserves by central banks has become a central issue in economic debates. Far from being a quarrel between experts, it reveals a profound divide between worldviews: what are money, public debt, and the role of the state in their management?

This article traces the history of this silent revolution born of the 2008 crisis, confronts the justifications of orthodoxy with the radical critiques of Modern Monetary Theory (MMT), and highlights the eminently political dimension of this monetary choice. It shows how a seemingly technical decision opened a Pandora’s box, raising questions of sovereignty, democratic legitimacy, and fiscal management.

Beyond the technical aspect, what is at stake is an ongoing redefinition of the very foundations of our social and economic contract.

---

Introduction

The remuneration of bank reserves by central banks—Interest on Reserves (IOR)—might seem like a technical detail of monetary policy. In fact, it has become the unexpected focal point for debates touching on the very essence of money, public debt, and the role of the state.

Since the 2008 crisis, IOR has profoundly transformed central banking practices: by making it possible to maintain positive rates despite a structural excess of reserves, it has made it possible to manage rates without reducing the size of balance sheets. However, this mechanism has a considerable fiscal cost: it results in a massive transfer of public revenue to the banking sector and blurs the line between monetary and fiscal policy.

By agreeing to remunerate trillions of dollars in reserves, central banks are exercising a redistributive power that traditionally falls within the purview of government and democratic control. Their primary competence—price stabilization—is thus de facto extended to choices with fiscal and social effects, without an explicit mandate.

But the IOR also reveals a truth that economic orthodoxy strives to conceal: the issuance of government securities, far from financing government spending, serves no other purpose than to set a positive interest rate on government liabilities and offer a risk-free asset to the private sector.

Why do we continue to issue government securities if the IOR allows us to control interest rates? Are we ready to recognize that public debt is above all a political choice, not a natural constraint? Through the prism of the IOR, a redefinition of the role of financial markets, central banks, and fiscal democracy is taking shape.

This article aims to trace the emergence and institutionalization of the IOR, to compare the opposing paradigms it reveals, and to explore the possible consequences of this monetary choice that has become political. It will be structured as follows: it will first revisit the historical genesis of this practice, showing how a paradigm shift has silently taken place (1). It will then expose the fundamental ideological divide that pits the orthodox vision against that of MMT (2). It will then analyze the cross-cutting implications of this dispute on the budgetary, democratic, and economic policy fronts (3). Finally, it will explore its most destabilizing consequence – the possible obsolescence of government securities markets (4) – as well as the exit routes and reforms envisaged to break the current impasse (5).

⤵️ To understand how a mechanism as technical as the remuneration of reserves has become a central issue in economic debates, it is necessary to first focus on the evolution of the instruments by which governments and central banks have historically controlled their interest rates: government securities, once essential, and today remunerated reserves.

1. Genesis of a Controversy: The History of a Silent Monetary Revolution

1.1. The World Before (Pre-2008): Steering by Scarcity

Before the great financial crisis of 2008, the world of monetary policy seemed governed by a predictable, well-oiled clockwork. The primary objective of central banks like the US Federal Reserve (Fed) or the European Central Bank (ECB) was to precisely control a single interest rate: the overnight interbank market rate, at which banks lend each other their liquidity (the Fed Funds Rate in the United States, the EONIA in Europe). It was this rate that, in turn, influenced all credit conditions in the economy.

The fundamental principle of this system was based on a simple concept: organized scarcity. Reserves – that is, the deposits that commercial banks are required to hold at the central bank¹ – were essential to the proper functioning of the payments system. However, the central bank ensured that the total amount of reserves available in the system was maintained at a minimum level, barely sufficient to cover the banks’ needs. This deliberate scarcity forced banks lacking liquidity to borrow from those with excess liquidity, thus creating an active interbank market. Thus, before 2008, to achieve their interest rate target, central banks had to constantly adjust the amount of available reserves through open market operations. Rate control was therefore indirect and involved active scarcity management.

To control this market, central banks operated within a « corridor system. » This framework was delineated by two rates that they directly controlled:

A ceiling, the marginal lending window rate, at which a bank could always borrow as a last resort from the central bank. No bank therefore had any incentive to borrow on the market at a higher rate.

A floor, the deposit facility rate, at which a bank could deposit its excess liquidity. This rate was often set at zero, or even nonexistent.

The central bank’s target policy rate fell between this floor and this ceiling. The standard view of this mechanism, as presented by central banks (Clews et al., 2010), was that of a quantity adjustment: the central bank shifts the supply of reserves to intersect the demand curve at its target rate. The daily instrument of this high-precision steering was open market operations. By buying or selling small quantities of government securities, the central bank could inject or withdraw reserves from the banking system, thus influencing supply and demand in the interbank market to keep the effective rate as close as possible to its target.

In this context, the question of remunerating reserves was, for the most part, a political non-issue. Yet it was far from a new idea and had its roots in the most fundamental economic debates. As economist Peter Ireland (2019) points out, it was figures as prestigious as George Tolley and especially Milton Friedman who, as early as the 1950s and 1960s, had put forward the argument of economic efficiency. For Friedman, since reserves can be created at zero marginal cost by the central bank, efficiency dictates that their opportunity cost for banks should also be zero. Paying reserve requirements at a market rate was therefore, in his view, a way to eliminate the implicit « tax » they represented.

But it was Fed economist Marvin Goodfriend (2002) who, in a remarkably prescient article, went much further. He was the first to describe in detail the « floor system » we know today, understanding that remunerating reserves would allow us to « decouple » interest rate policy from balance sheet policy. For him, therefore, remunerating reserves was not a simple adjustment, but the key to a new monetary paradigm.

This analysis was shared, on a purely operational level, by Warren Mosler (1995), the « father » of MMT. Well before the crisis, he already described unremunerated reserve requirements as a « reserve tax » that created an economic distortion. Paying interest on these reserves was, within his framework, a simple way to eliminate this tax.

No one imagined at the time that this tool, conceived as a marginal technical correction for a system in scarcity, would one day be applied to trillions of excess reserves, transforming a minor compensation into what modern critics would call a massive subsidy.

Indeed, this idea, initially conceived as a technical refinement, would find, with the 2008 crisis, a field of application of a then-unimaginable scale. This orderly world, based on scarcity and marginal interventions, would be swept away by the financial tsunami, forcing central banks to transform this expert debate into the new cornerstone of their policy.

1.2. The 2008 Disruption: The Era of Quantitative Easing and Abundance

The well-ordered edifice of monetary policy collapsed in the fall of 2008. Faced with the paralysis of the global financial system, traditional tools proved powerless. Lowering the key interest rate to zero, the conventional response to a recession, is no longer enough to revive an economy in shock and a banking system lacking confidence. To avoid a depression of historic proportions, central banks are forced to think outside the box and unleash an unconventional weapon: quantitative easing (QE).

The principle of QE is simple in its execution. Central banks begin massive purchases of financial assets, primarily government debt securities, but also corporate bonds. In exchange for these assets, the central bank does only one thing: it credits, through a simple electronic transaction, the reserve accounts of the selling commercial banks. The effect is immediate and spectacular: central bank balance sheets swell exponentially, from a few hundred billion to several trillion dollars and euros.

This massive policy of asset purchases destroys the founding principle of scarcity. The monetary system, once maintained in a state of mild liquidity shortage, is now flooded. Bank reserves are no longer a scarce resource that banks trade on an active market; they have become an overabundant resource, a « liquidity blanket » covering the entire financial system.

In such an environment, the scarcity-based mechanism can no longer function. The interbank market dries up, because a bank overwhelmed by reserves has no incentive to borrow from its competitors. Deprived of any tension, the interbank rate naturally collapses towards its zero lower bound, effectively escaping the central bank’s control. The latter finds itself facing an existential dilemma: it has managed to save the system from collapse, but in doing so, it has lost its main lever for steering interest rates. Therefore, in order to avoid becoming a pilot without a steering wheel, and to regain the ability to influence monetary conditions in the future, it had to invent a new operating mode.

1.3. The Institutionalization of a New Tool

Thus, faced with the dilemma created by the abundance of reserves, central banks could not resign themselves to impotence. To regain control of interest rates without having to prematurely dismantle their QE programs, which would have risked provoking a new shock in the financial markets, they had to undertake a Copernican revolution in their approach. Rather than controlling rates by influencing the quantity of reserves, they would now control them by influencing their price.

The solution was the widespread introduction of interest on reserves (IOR). By deciding to pay interest on the balances that commercial banks held in their accounts with the central bank, the latter created a new effective floor rate. The logic is undeniable: no bank has any interest in lending its liquidity on the interbank market at a rate lower than the one it can obtain, without the slightest risk and without effort, by simply letting it sit at the central bank. The interest rate on reserves thus became the new rudder of monetary policy.

This paradigm shift, from the « corridor system » to the « floor system, » had a fundamental consequence: it « decoupled » interest rate policy from the size of the central bank’s balance sheet. From then on, the central bank could maintain a gigantic balance sheet while being able, if necessary, to increase its key interest rate simply by raising the interest rate on reserves. The dilemma was resolved. The central bank could now continue its QE programs—perceived as support for the economy—while regaining the means to act in the event of a return of inflation. Indeed, the IOR allowed it, if necessary, to increase its key interest rate without having to shrink its balance sheet. In other words, the IOR made possible the coexistence of a huge balance sheet (the legacy of QE) with a potentially restrictive interest rate policy (the fight against inflation).

What was conceived as a pragmatic and technical response to a crisis situation quickly became institutionalized and became the new normal.

More recently, during the review of its operational framework in March 2024, the ECB officially confirmed that it would continue to operate within what is technically a « floor system. » Without using these exact terms, its statement specified that it « will maintain the monetary policy stance through the deposit facility rate (DFR) » (ECB, March 13, 2024), which is the operational definition². This statement thus validates the paradigm shift imposed by the abundance of liquidity. The remuneration of reserves, once a matter of expert debate, has become the central instrument of modern monetary policy.

Thus, through a twist of history, a technical solution opened a veritable Pandora’s box. By transforming reserves, a simple unit of settlement, into a large-scale interest-bearing financial asset, central banks unwittingly sowed the seeds of a profound controversy over the nature of money, the role of government securities, and the legitimacy of their power. The silent revolution was complete, and the time for questioning could begin.

⤵️ This shift from a system based on the scarcity of reserves to a system of abundance driven by the IOR is not just a technical development: it crystallized an opposition between two visions of money, public debt, and the role of the state.

2. The Paradigm Fracture: Two Irreconcilable Visions of Money and Debt

2.1. The Orthodox Vision: Stability at All Costs (The Cochrane Argument)

For the orthodox school of economic thought, which dominates most central banks, the proposal to eliminate interest on reserves is an aberration based on a misunderstanding of the fundamental mechanisms of public finance. The response of its proponents often begins with a provocative counter-question: « If it’s such a good idea, why not stop paying interest on all government securities? » (Cochrane, 2024).

This analogy establishes the central premise of this vision: bank reserves are nothing more than a form of very short-term (overnight) public debt. Therefore, ceasing to pay interest on them when other interest rates are positive would create an untenable situation. Banks, unwilling to hold an asset that yields no income, would seek to divest themselves of it en masse. For the regulator, this would leave only two options, both disastrous:

1. A brutal liquidation of quantitative easing: The first option would be to allow banks to get rid of their reserves. To do this, the central bank would have to absorb these trillions by massively selling the securities in its portfolio. Such an operation, a « quantitative tightening » carried out at a forced pace, would not only be technically perilous, but it would also reveal the colossal accounting losses incurred by the central bank on its portfolio of bonds purchased during the low interest rate era.
2. The introduction of « financial repression »: The second option would be to force banks to hold these uninterested reserves. This would amount to imposing a massive implicit tax on the banking sector. Such « financial repression » would create major distortions, penalizing depositors (via lower rates) and borrowers (via higher rates), and would encourage capital flight to shadow banking, a less regulated financial ecosystem and therefore more risky for global stability.

From this perspective, far from being a « subsidy, » the remuneration of reserves is the sine qua non for maintaining the current financial architecture. It is the centerpiece of the central bank’s role as a gigantic « maturity transformer »: by exchanging long-term government securities for short-term reserves, it provides the necessary liquidity to the system. The remuneration of these reserves is simply the price to pay for this essential stability service. Trying to eliminate it without dismantling the entire post-2008 edifice would be, to borrow Cochrane’s phrase, as absurd as defaulting on part of the public debt.

2.2. The Heterodox Vision (MMT): The Creative Power of the Sovereign State

Modern Monetary Theory (MMT) approaches the question by reversing the orthodox perspective. It does not start from theory, but from the operational observation of monetary flows between the state and the private sector.

An analysis of the daily operations of the Treasury and the central bank reveals an inescapable accounting fact: sovereign state spending logically and technically precedes tax collection or the sale of securities. When the state spends, it directly credits bank accounts, which increases the reserves of commercial banks. Consequently, if the state spends more than it taxes (a deficit situation), it injects net reserves into the system. This surplus liquidity, left to its own devices, exerts downward pressure on its price, the overnight interest rate, which inevitably converges towards zero.

Therefore, as Warren Mosler demonstrated in his seminal text, Soft Currency Economics (1995), any positive interest rate is a public policy choice, not a market condition. To maintain a rate above zero, the government must intervene to counter this natural tendency. The tool historically used for this purpose is the issuance of government securities. As economists such as Scott Fullwiler (2005), Wray (1998), and Kelton (Bell, 2000) have formalized, the sale of securities by the Treasury is not a financing operation, but an « interest rate maintenance operation. » It serves to drain excess reserves to create artificial scarcity and thus support the target rate. The issuance of securities is therefore a monetary policy instrument disguised as a financing operation.

This is where the interest on reserves (IOR) acts as a powerful indicator. Mosler demonstrated, well before the 2008 crisis, that IOR was an alternative, more direct and transparent method for achieving exactly the same objective. Instead of draining reserves by selling securities, the central bank leaves them in the system and decides to remunerate them directly at the desired rate.

IOR is therefore a functional substitute for issuing securities. But where orthodox economists like Goodfriend saw it as a new tool to strengthen the power of the central bank, Mosler saw it as confirmation that the monetary function of government securities was entirely optional. The remuneration of reserves thus exposes a fundamental reality: it is a political choice, a subsidy paid to the financial sector, which reveals the uselessness of issuing securities for the conduct of monetary policy.

This framework helps us understand the fundamental misunderstanding that, according to MMT, has surrounded Quantitative Easing (QE) since its inception. While QE, like the public deficit, created an abundance of reserves, its nature and effects on the real economy are radically different.

Indeed, it is essential to understand the double misconception that, according to MMT analysis, surrounded QE from its inception. First, contrary to popular belief, QE is not a net wealth creation³ for the private sector, but a simple asset swap. The central bank removes one financial asset (a government security) from the banks’ balance sheets and replaces it with another (reserves). The total quantity of net financial assets held by the private sector remains unchanged.

Second, the expectation of a real economy boost through credit was based on the persistent myth of the « money multiplier. » This erroneous assumption assumed that banks, with more reserves, would automatically create more loans. However, banks do not lend their reserves; they extend credit based on the demand from solvent borrowers. The abundance of reserves therefore did not create a credit boom in the real economy, but rather contributed to the inflation of financial asset prices.

Consequently, as Warren Mosler summarizes, the main effect of QE was not to boost aggregate demand, but to modify the structure of interest rates by influencing asset prices. This initial confusion about the nature of QE is the key to understanding why its effects were so different from initial expectations.

These realities, whose basis is primarily accounting and long ignored by conventional approaches, find in MMT a coherent framework rigorously anchored in the actual functioning of the monetary system.

⤵️ Beyond the theoretical differences, these two paradigms lead to major practical consequences, affecting public finances, democracy, and the very functioning of the economy.

3. Cross-Cutting Issues: When Monetary Technique Becomes Political

3.1. The Budgetary and Fiscal Issue: The « Opaque Subsidy »

Beyond the ideological divide, the remuneration of reserves has tangible and immediate consequences. The most direct is its cost to public finances, a cost that has exploded with the rapid rise in interest rates initiated by central banks since 2022 to combat inflation.

The mechanism is simple: the central bank, by remunerating reserves, pays interest income to commercial banks. These payments constitute an expense for the central bank. However, a central bank is not a business like any other: the bulk of its profits is traditionally returned to its country’s treasury. Consequently, every euro or dollar paid to commercial banks is a euro or dollar that will not be transferred to the state budget. This mechanism can therefore be analyzed as a transfer of wealth from the public to the private banking sector.

The scale of this transfer has become colossal. With trillions in reserves inherited from QE and key interest rates exceeding 4% or 5%, the sums paid out amount to hundreds of billions per year,⁴ in both the eurozone and the United States. For many critics, and particularly explicitly for MMT economists, this is a massive subsidy, granted without any clear counterpart. Indeed, the reserves on which this interest is earned were created ex nihilo by the central bank itself during its QE operations. The banking sector thus finds itself receiving a guaranteed, risk-free income on an asset it received without effort⁵.

It is essential to understand the nature of this « cost » criticism within the framework of MMT. It is not a question of saying that the government « lacks the money » to pay this interest. The criticism is distributional and opportunity cost-based. For MMT, every euro paid without compensation to the banking sector is a euro that the state chooses not to spend on public interest objectives such as the ecological transition, healthcare services, or job creation. The « cost » is therefore not financial for the currency issuer; it is social and political, representing a decision that favors financial rents at the expense of the real economy.

The budgetary challenge has become all the more acute as central banks themselves have found themselves in a situation of accounting losses. The interest they pay on reserves (at variable rates) has ended up exceeding the income they generate from their bond portfolios (purchased at a time of low interest rates and therefore low yields). The example of the ECB is striking: in its annual accounts for 2023, it announced a zero profit, explaining that the cost of remunerating reserves had exceeded its income. This situation suspends any redistribution of profits to Member States for several years, thus materializing the direct fiscal cost of this policy.

The remuneration of reserves is therefore not a neutral operation for the taxpayer. It has a direct fiscal cost, by depriving the State of revenue, and an indirect one, by supporting the profitability of the banking sector in a way that eludes traditional budgetary debate. It is this opacity that fuels criticism of a policy that, under the guise of monetary technicality, organizes large-scale redistribution.

Faced with the accusation of subsidy, defenders of the system, such as John Cochrane (2024), retort that this view is based on an accounting error. For them, since reserves and government securities are both forms of public debt, the remuneration of the former is no more a subsidy than that of the latter.

However, this analogy is misleading. It ignores a fundamental difference: unlike government securities voluntarily subscribed by the public, excess reserves were created and imposed on the banking system by the central bank’s own action (QE). Their remuneration is therefore not the counterpart of risk-taking or a savings decision by the private sector, but rather an income paid on a currency created ex nihilo by the public authorities. To describe this transfer as a simple internal accounting game is to deny its very real distributional consequence: direct and risk-free support for the profitability of the banking sector, financed by the community.

3.2. The Political and Institutional Challenge: The Abuse of an Unelected Power

While the budgetary stakes are considerable, it is perhaps in the realm of democratic legitimacy that the remuneration of reserves poses the most fundamental challenge. This criticism, formulated with particular force by system insiders themselves, does not call into question the technical effectiveness of the tool, but its compatibility with the principles of the rule of law.

The first aspect of this criticism, embodied by Paul Tucker, former Deputy Governor of the Bank of England, focuses on the decision-making process. For him, an independent central bank derives its legitimacy from its narrow and technical mandate—typically, price stability. But when its actions resemble fiscal decisions, involving significant and targeted transfers of wealth to a particular sector, it crosses a red line. Yet, the remuneration of reserves, by allocating hundreds of billions to the banking sector, is precisely what Tucker calls a « quasi-fiscal operation. » It is a choice that, in a democracy, should be the responsibility of the elected power (Parliament). By making such an autonomous decision, the central bank assumes a power that has not been delegated to it, an « unelected power. »

The second part of the critique, led by economists like Peter Ireland, focuses on the nature of the actions made possible by this tool. He denounces « mission creep. » By allowing the central bank to indefinitely maintain a gigantic balance sheet, the remuneration of reserves transforms it from a neutral monetary arbiter into a key economic and political actor. By massively purchasing not only Treasury securities but also mortgage-backed securities (MBS), the Fed has actively engaged in credit allocation, favoring the housing sector at the expense of others. She therefore made an eminently political choice, one that falls outside her mandate.

These two criticisms are two sides of the same coin. The « quasi-fiscal » decision (Tucker’s criticism) is not an abstraction; it materializes through concrete credit allocation actions (Ireland’s criticism) that change the very nature of the institution. This situation creates a dangerous paradox: the independence of central banks, designed to protect them from political pressure, is now threatened by their own actions. By venturing into the fiscal arena and acting as credit allocators, they inevitably expose themselves to political criticism and undermine the democratic foundation on which their credibility rests.

Paradoxically, this shift is precisely what certain heterodox proposals, such as the « debt-free currency » put forward in France by Jézabel Couppey-Soubeyran et al. (2024)⁶ and Alain Granjean & Nicolas Dufresne⁷ (2020) would like to amplify this. By suggesting entrusting the central bank (or an ad hoc issuing institution) with the power to create and distribute money for public interest objectives, these proposals would lead to what Tucker and Ireland fear most: an unelected institution choosing the winners and losers in economic policy.

It is precisely to avoid this drift that MMT analysis positions itself in direct opposition. For MMT, the power of net money creation already exists and belongs to the government via fiscal policy. There is therefore no need to create a new currency described as « debt-free » or to grant new powers to the central bank. On the contrary, by insisting that the power to spend and allocate resources remain exclusively in the hands of Parliament, MMT offers a solution that addresses Tucker and Ireland’s criticism.

This approach also differs from the purely operational analysis of Scott Fullwiler (2014), who, without proposing to reform the institution, demonstrates that any « debt-free money » system logically leads to a permanent zero interest rate policy (« ZIRP Forever »), thus confirming that the function of government securities is indeed to enable a positive interest rate policy.

The frequent confusion between these different heterodox approaches partly explains the accusation of « magic money » leveled at MMT, even though the latter is intended to be a rigorous description of existing powers and a plea for the primacy of democratically decided fiscal policy over monetary policy conducted by technocrats.

3.3. The Economic Policy Challenge: The « Arsonist Firefighter »

Beyond questions of fiscal cost and democratic legitimacy, the remuneration of reserves calls into question the very effectiveness of monetary policy. Since 2022, central banks’ strategy to combat inflation has been the subject of strong criticism: by raising rates to slow the economy, they are simultaneously injecting massive revenues into the financial system. Hence the image of the « arsonist firefighter. »

MMT analysis, notably by Mosler and Armstrong (2019), highlights an often-ignored channel: net interest income paid by the government. As the government is a net payer, a rise in interest rates fuels a flow of revenues to the private sector. This expansionary effect can offset, or even exceed, the restrictive effect on private borrowers.

This analysis is also corroborated, albeit from a different perspective, by economists such as Paul De Grauwe (De Grauwe & Ji, 2023). They empirically demonstrate that the income generated by the remuneration of reserves increases banks’ equity, which encourages them to lend more. This « reverse equity effect » therefore directly weakens the transmission of monetary policy, which specifically aims to restrict credit.

Thus, on the one hand, central banks attempt to curb demand by making credit more expensive for households and businesses. On the other, they distribute risk-free income that supports bank profitability and lending capacity. Monetary policy acts as both a brake and an accelerator.

The mechanics of this observation are not disputed: even orthodox economists such as John Cochrane (2024) acknowledge that the central bank creates reserves to pay this interest. The disagreement lies in interpretation: while critics see an expansionary effect that weakens monetary policy, advocates see it as nothing more than an accounting game with no real consequences.

This paradox reflects a profound inconsistency: a tool designed for a deflationary environment (QE and IOR) becomes counterproductive in a period of inflation. By seeking to extinguish the fire by raising rates, central banks are also fueling the very flames they want to fight. Current monetary policy thus fully illustrates the paradox of the arsonist firefighter.

⤵️ These cross-cutting elements reveal that the remuneration of reserves and the issuance of government securities are not independent instruments, but two sides of the same coin. So, what role does government securities play in a world where IOR is sufficient to control rates?

4. The Ultimate Consequence: Towards the End of Government Securities?

While the fiscal, democratic, and economic policy stakes are already considerable, the remuneration of reserves carries an even more fundamental implication, a logical conclusion that could dynamite the architecture of public finance as we have long known it. It is by following the reasoning of MMT to its conclusion that this ultimate consequence becomes clear.

4.1. The Logical Short Circuit: When Reality Exceeds Fiction

The true conceptual earthquake caused by the remuneration of reserves is revealed when it is confronted with the operational analysis of the role of government securities. As this analysis demonstrates, the issuance of securities by a sovereign state does not serve to « finance » its expenditures, but primarily fulfills three distinct functions:

1. A monetary policy function: Supporting a positive target interest rate by draining excess reserves from the system.
2. A savings function: To provide risk-free, interest-bearing support to the private sector.
3. A treasury function: For Eurozone countries, this involves helping to maintain a positive balance in the Treasury account with the ECB every evening, as required by Article 123 of the TFEU.

However, the institutionalization of the remuneration of reserves (IOR) has disrupted this arrangement. By entirely replacing the first of these two functions, it acts as a powerful indicator. It is now the central bank that, by directly setting the price of basic liquidity (reserves), establishes the floor for interest rates. The complex and indirect tool of selling securities to control interest rates has, in fact, become superfluous, as economist Scott Fullwiler anticipated as early as 2005.

The logical short circuit is therefore as follows: if government securities are not necessary to finance the government, and they are no longer necessary to regulate interest rates, then their primary operational justification has disappeared.

The practice of remunerating reserves, introduced to preserve the orthodox framework of thought, has paradoxically provided a factual and irrefutable demonstration of the operational analysis at the heart of MMT. It has proven through action, not theory, that the government can perfectly control interest rates without resorting to issuing securities. The question that then arises is disarmingly simple: if their monetary function has disappeared, why continue to issue them?

However, for eurozone countries, this logical conclusion runs into a difficult institutional barrier: the European treaties themselves. The third function of government securities—cash management—is not a mere convention, but a legal constraint enshrined in the euro’s founding pact. Article 123 of the Treaty on the Functioning of the European Union (TFEU) formally prohibits the ECB and national central banks from granting overdrafts or any other type of credit to governments.

This prohibition of « monetary financing » is the dogma on which the entire economic architecture of the Eurozone was built. It obliges national treasuries to maintain a credit balance in their account with the central bank, thus forcing them to « find » euros through taxes or debt issuance before being able to spend. Removing the need to issue securities would therefore amount to dismantling this fundamental pillar.

However, amending the TFEU is an extremely politically complex process. This would require a revision of the treaties, a process that requires unanimity among member states, followed by ratification by each national parliament, and sometimes by referendum. In the current political climate, marked by a deep ideological divide between the Northern countries, committed to « fiscal discipline, » and those of the South, such unanimity is simply unthinkable. Any attempt to relax Article 123 would be perceived as a radical challenge to the Maastricht model and would open a political Pandora’s box that no one wants to confront. The eurozone therefore finds itself in a paradoxical situation: while operational reality has rendered the monetary function of government securities obsolete, its legal and political fiction remains set in stone in the treaties, creating a major institutional blockage for years to come.

4.2. What Function for Government Securities Tomorrow?

If the monetary policy function of government securities has been rendered obsolete by the remuneration of reserves, what remains to justify their existence? The answer depends crucially on the institutional framework. For a fully monetary sovereign state, such as the United States or the United Kingdom, only the second function identified above remains: that of serving as a risk-free savings vehicle for the private sector. However, for eurozone countries, the legal constraint of Article 123 of the TFEU maintains the necessity of the treasury function, making the issuance of securities mandatory for the management of the state’s financial flows.

Focusing for the moment on the case of a sovereign state—or on what would become possible in a reformed eurozone—MMT logic leads to a radical conclusion. The only reason such a state would still issue securities would be to meet the demand of non-banking stakeholders (households, pension funds, insurers) who wish to hold a safe, interest-bearing financial asset. Issuing securities would then cease to be a constraint imposed on the state and become an optional public service, a deliberate policy aimed at providing a certain savings structure for the economy.

This radical redefinition of the role of government securities leads directly to the proposal formulated by Warren Mosler. If the sole objective is to satisfy a savings need, why should a sovereign state continue to issue a whole range of complex instruments, with maturities spanning several decades? Why impose a cost and risk structure on itself that is no longer justified by any operational necessity? Mosler’s proposal is pragmatically simple: such a state should stop issuing long-term securities and limit itself to offering a single type of financial instrument, for example, 3-month Treasury bills. This simple instrument would be more than sufficient to fulfill the function of risk-free savings, while minimizing interest costs for the community. Managing government securities would no longer be a complex exercise in navigating financial markets, but a simple administrative operation. The relevance of issuing government securities is thus established: for monetarily sovereign nations, their existence is already a simple political choice, and no longer an economic inevitability, while for members of the euro, it remains an institutional obligation.

4.3. The Implications of a World Without an Active Bond Market

Conceiving a world where the State would no longer be forced to issue a diverse range of medium- and long-term securities would mean imagining a profound transformation, not only of public finance, but of financial capitalism as a whole. If the issuance of government securities were reduced to a simple short-term savings service, the implications would be systemic.

First, it would signal the end of « market discipline, » a central concept in economic discourse in recent decades. The fear of soaring interest rates on long-term debt, often touted as a safeguard to limit deficits, would lose all substance. Concretely, this would mean the end of sterile debates on debt ceilings, the end of budgetary « golden rules » that curb public investment and, above all, the end of austerity policies pursued in the name of the phobia of an arbitrary « public debt »/GDP ratio. As Mosler emphasized in the introduction to « Soft Currency Economics », the real question for a government is never financial accessibility, but the availability of real resources. Similarly, as economist Bill Mitchell (2016) summarizes, it marks the end of the « morality game » regarding debt, the end of anxiety-inducing questions about « who will buy our securities? », and a way to « neutralize the power of rating agencies and other fiscal watchdogs. » The political debate would shift from financial constraints, recognized as an artificial construct, to the management of the true limits of the economy: its productive resources.

Second, it would trigger a revolution in the financial sector itself. Sovereign securities markets currently constitute the foundation of the entire system. They serve as a benchmark for pricing all other assets. Their marginalization would force global finance to reinvent itself and find new pricing references, likely based on private instruments or new creations by central banks.

Third, it would signal the advent of a new paradigm of macroeconomic management. In a world where interest rates If interest rates were sustainably low (close to zero) and the issuance of securities was no longer a constraint, monetary policy would lose its leading role. The burden of managing inflation, employment, and growth would then fall almost entirely on the shoulders of fiscal policy. Adjusting taxes and public spending would become the primary tool for economic management, shifting the center of power from technocratic central banks to democratically elected parliaments.

This world without an active bond market, as it emerges from operational analysis, is therefore much more than a simple technical adjustment. It represents a fundamental shift in the distribution of power between the state, markets, and citizens, freeing democratic debate from self-imposed financial constraints.

⤵️ The questioning of government securities as a monetary management tool brings us to a crossroads: should we continue on this trajectory and accept its political implications, or should we seek to return to an older model, based on strict rules and limits to the role of the central bank?

5. Ways Out and Political Compromises

Faced with the economic, budgetary, and democratic contradictions raised by the remuneration of reserves, several ways out are emerging. They all address the same question: how can we resolve the problems posed by the current system of abundant reserves? Possible responses range from maintaining the status quo to radical reforms, as the controversy touches on the very foundations of our economic governance: the necessity of public debt, the role of financial markets, and the boundary between the power of technocrats and that of elected officials. The first, and for the moment the most likely, of these trajectories is that of inertia and the maintenance of the current system.

5.1. The Status Quo: A « Marvelous Innovation » Grappling with Its Contradictions

Far from being the result of simple inertia or cautious conservatism, maintaining the current system is strongly defended by a section of the orthodox movement as a major step forward, a policy to be actively preserved. From this perspective, the pre-2008 world, that of scarce reserves, is not a lost paradise but an era of unnecessary complexity and volatility.

For economists like John Cochrane (2024), the « good old days » were actually « horrible, » marked by spikes in volatility in the interbank market and a considerable waste of time and resources for banks in cash management. The system of abundant reserves remunerated at market rates would therefore be a « marvelous innovation. » It would represent the practical application of the « Friedman rule, » a theoretical ideal in which the system’s base currency finally pays market interest, thus eliminating the distortions and transaction costs of the old system.

From this perspective, preserving the status quo is not a rejection of change, but rather a defense of conceptual and technical progress. This explains why central banks cling to this framework: it offers them direct and simple control over short-term rates, without requiring them to engage in the perilous management of their balance sheet size. For its supporters, the benefits of this innovation in terms of stability and simplicity far outweigh criticisms regarding its fiscal cost or its « quasi-fiscal » nature, which are deemed secondary or poorly understood.

This defense of monetary modernity, however, faces a major contradiction, highlighted by MMT analysts. As Phil Armstrong (2019) summarizes, this new operational framework is maintained within a set of « self-imposed constraints » inherited from the gold standard, such as debt ceilings, the prohibition on direct purchases of Treasury securities, and the requirement for the Treasury to maintain a positive balance. These rules, which no longer have any operational justification, continue to restrict public action for purely ideological reasons, creating a hybrid and incoherent system.

This vision of the floor system as a definitive step forward, however, is not unanimously shared within the institutions themselves. As early as 2010, the Bank of England (Clews et al., 2010), through its economists, expressed its intention to « reinstate, when the time comes, its version of the corridor system, » viewing the current framework as a temporary adaptation to the exceptional circumstances of QE. This position reveals a tension within orthodox thinking itself, between those who see the abundant reserve system as a new ideal and those who perceive it as a degraded regime from which it will eventually be necessary to escape.

5.2. Pragmatic Reforms: The Search for a Third Way

Faced with growing criticism but frightened by the prospect of a radical paradigm shift, many economists and policymakers are seeking a third way. The objective of these pragmatic reforms is not to revolutionize the system, but to amend it to correct its most glaring excesses, particularly the budgetary cost of remunerating reserves. Two main proposals emerge from this reform movement.

The first proposal, and the most debated within institutions, is that of « tiering. » This is not just a theoretical hypothesis: the European Central Bank itself implemented such a system between 2019 and 2022 to mitigate the impact of negative rates on bank profitability. The debate resurfaced forcefully during the rate hike, given the growing cost of remunerating reserves for the ECB.

As market strategists analyze in detail (Bouvet & Schroeder, 2022), a tiering system could take several forms. It could consist of not remunerating (or remunerating at 0%) a portion of reserves proportional either to the former targeted loans (TLTROs) or, more permanently, to a multiple of the banks’ reserve requirements. The objective is always the same: to reduce the total amount of interest paid by the central bank.

The challenge of such a reform, highlighted in the analysis, is the calibration of the « threshold » of unremunerated reserves. If it is too low, the cost reduction for the ECB is limited. If it is too high, it risks creating major disruptions in the money market, forcing banks that find themselves below the threshold to lend their liquidity at any price. Implementing such a system is therefore a delicate exercise that aims to reconcile cost control for the public sector with financial market stability.

The second, more structural proposal, which has been the subject of a detailed analysis by Paul De Grauwe and Yuemei Ji (2023), is that of a « two-pillar system. » Their compromise solution consists of significantly increasing the level of required reserves, which would not be remunerated. Banks would only earn interest on reserves held above this threshold. The advantage of this approach is twofold: it drastically reduces the « subsidy » to banks, while allowing the central bank to maintain its current operational framework (the floor system). Moreover, by reducing a portion of bank profits, it would strengthen the effectiveness of monetary policy in its fight against inflation.

These reforms represent an attempt at compromise. They acknowledge the validity of the criticism regarding the exorbitant cost of remunerating reserves, but refuse to abandon the idea that the central bank must actively manage interest rates and that the financial system needs a positive interest rate floor. They aim to make the current system more sustainable politically and fiscally, without subscribing to MMT’s most radical conclusions about the nature of money and the uselessness of government securities.

5.3. The Radical Path: The MMT Proposal, a Strategy of Political « Disarmament »

In contrast to pragmatic reforms that seek to amend the existing system, Modern Monetary Theory proposes a coherent but radical solution: accepting all the logical conclusions of its accounting and operational analysis. As Stephanie Kelton and Scott Fullwiler (2024) cogently present, this is not simply a matter of choosing a technical option, but of adopting a strategy to clarify the public debate.

The central proposal of MMT combines two decisions: to cease all issuance of government securities and to permanently set the central bank’s key interest rate at zero (ZIRP). This combination reflects a fundamental observation, established as early as Mosler & Forstater (2005): in a sovereign monetary system, the natural rate of interest is zero. Any positive rate necessarily implies a deliberate choice by the government to remunerate its liabilities (reserves or securities). Scott Fullwiler’s (2014) analysis of « debt-free money » proposals reinforces this point: a system in which the government spends without offering remunerative instruments (securities or reserves) necessarily leads to ZIRP.

This confirms a central principle of MMT: the government’s liabilities (cash, reserves, securities) do not exist to finance its spending, but to provide the private sector with safe assets and to enable interest rate control. If a zero rate is accepted, the control function disappears, and debt becomes optional. MMT recognizes this dilemma: either maintain interest-bearing liabilities to pursue a positive interest rate policy, or choose ZIRP and stop issuing securities.

This choice is primarily political. Stephanie Kelton illustrated this in the US Senate: public debt is systematically used to block social policies. By ceasing to issue securities, we remove the main weapon of the guardians of fiscal austerity. As Bill Mitchell (2016) summarized, this choice makes it possible to:
– put an end to the « morality game » surrounding debt and the obsession with repayment;
– neutralize the power of rating agencies;
– focus the debate on the real risk: inflation and the management of real resources.

The consequence of such « disarmament » is therefore clear: monetary policy would lose its leading role: economic regulation would once again become the responsibility of the budget, that is, of Parliament.

This project of « liberating » fiscal policy therefore places MMT in direct opposition not only to the status quo, but also to the other radical critique of the system, that put forward by economists like Peter Ireland (2019). The debate on the remuneration of reserves thus reveals not two, but three irreconcilable visions of the management of monetary power:

The orthodox vision (Cochrane), which seeks to preserve strong discretionary power in the hands of the central bank, deemed essential to guarantee financial stability.

The libertarian vision (Ireland), which, conversely, seeks to dismantle this discretionary power and constrain the central bank with strict rules to shield it from any political influence.

And the MMT vision, which, by revealing that money is a public tool by nature, aims to transfer the center of macroeconomic power from the central bank to democratic institutions (Parliament and the government) via fiscal policy.

The technical dispute over the remuneration of reserves thus leads to a fundamental political question: who should have the power to regulate the economy?

⤵️ The debate over the remuneration of reserves thus appears to reflect a societal choice: do we want money to be a domain reserved for experts and markets, or should we place its major decisions within the realm of democratic sovereignty?

Conclusion

The debate over the remuneration of bank reserves, far from being limited to a technical or budgetary issue, reveals the true nature of our societies’ monetary choices. It highlights an observation that the history of monetary instruments and the emergence of the IOR have made undeniable: for a monetary sovereign state, public debt is not a financial need, but a political choice aimed at setting an interest rate on its liabilities and providing the private sector with safe assets. For eurozone countries, however, this function remains a cash flow necessity, a constraint enshrined in the treaties that only underscores the political nature of their monetary architecture.

By remunerating massive reserves, central banks have crossed a threshold: they now assume redistributive and quasi-fiscal choices without having an explicit democratic mandate. Their powers have expanded well beyond price stabilization, transforming their institutional role and blurring the line between monetary and fiscal policy.

At a time when government securities are becoming optional for managing interest rates, the central question is no longer: « How to finance the debt? » » but: « What governance do we want for our currency and our collective choices? » The status quo prolongs a financial technocracy that operates transfers without democratic debate. Prudent reforms adjust without refounding. The more radical path, as proposed by MMT, refocuses economic sovereignty on Parliament and fiscal policy.

The resolution of this technical controversy will therefore have significant consequences for the future conduct of economic policies. The answer will determine much more than the future financial architecture; it will define the future model of economic governance and resolve a fundamental question: who should have the power to regulate the economy? Technocratic central bankers, impersonal rules, or democratic debate?

---

References

Armstrong, P. (2019). An MMT perspective on macroeconomic policy space

Bell, S. (2000). Do Taxes and Bonds Finance Government Spending?. Journal of Economic Issues, 34(3), 603-620. (Note : Stephanie Bell est aujourd’hui connue sous le nom de Stephanie Kelton).

Bouvet, A., & Schroeder, B. (2022, 5 octobre). ECB reserve tiering: what’s the impact on euro money markets?. ING. Consulté sur https://think.ing.com/articles/ecb-reserve-tiering-whats-the-impact-on-euro-money-markets/

Clews, R., Salmon, C., & Weeken, O. (2010). The Bank’s money market framework. Bank of England Quarterly Bulletin, 2010 Q4, 292-300.

Cochrane, J. (2024, 22 Février). Interest on Reserves. The Grumpy Economist.

Couppey-Soubeyran, J., et al. (2024). Le pouvoir de la monnaie. Les liens qui libèrent.

De Grauwe, P., & Ji, Y. (2023). Towards Monetary Policies that do not subside banks

European Central Bank (ECB). (2024, 13 Mars). ECB announces changes to its operational framework for implementing monetary policy [Press release]

European Central Bank (ECB). (2024, 22 Février). Financial statements of the ECB for 2023 [Press release on the 2023 annual accounts].

Fullwiler, S. T. (2005). Paying Interest on Reserve Balances: It’s More Significant Than You Think. Social Science Research Network (SSRN).

Fullwiler, S. T. (2014, 3 juillet). “Debt-Free Money” and “ZIRP Forever”. New Economic Perspectives

Goodfriend, M. (2002). Interest on Reserves and Monetary Policy. Federal Reserve Bank of New York Economic Policy Review, 8(1), 77-84.

Grandjean, A., & Dufresne, N. (2020). Une monnaie écologique. Éditions Odile Jacob.

Ireland, P. N. (2019). Interest on Reserves: History and Rationale, Complications and Risks. Cato Journal, 39(2), 327-337.

Kelton, S., & Fullwiler, S. T. (2024).To Bond, or Not to Bond, that is the Question. UK MMT Conference, University of Leeds.

Mitchell, W. (2016). Overt Monetary Financing would flush out the ideological disdain for fiscal policy.

Mosler, W. (1995).Soft Currency Economics.

Mosler, W. (1997-1998). Full Employment and Price Stability. Journal of Post Keynesian Economics, 20(2), 167-182.

Mosler, W., & Forstater, M. (2005, Janvier). The Natural Rate of Interest is Zero [Paper presented at a conference]. Annual Meeting of the Association for Evolutionary Economics, Philadelphia, PA, USA.

Tucker, P. (2018). Unelected Power: The Quest for Legitimacy in Central Banking and the Regulatory State. Princeton University Press.

Wray, L. R. (1998). Understanding Modern Money: The Key to Full Employment and Price Stability. Edward Elgar Publishing.

---

Notes

1. The word « reserve » is ambiguous because it evokes the action of « setting something aside. » For the banking system, reserves are a liability that the government uses as a means of payment between the central bank and banks. In a monetary system, three types of government liabilities are possible, meaning that currency can take three forms: cash (coins and banknotes), government securities, and reserves. When a government spends, it credits a reserve account of the relevant bank opened in its records. Reserves are therefore nothing more than accounting records of transactions between the central bank and banks. They are also used to carry out interbank transactions. Reserves cannot leave banks because banks never lend reserves. They can, however, be converted into government securities or cash.

2. This press release can be viewed here : https://www.ecb.europa.eu/press/pr/date/2024/html/ecb.pr240313~807e240020.fr.html

3. In MMT jargon, QE does not cause the creation of Net Financial Assets.

4. The ECB will pay €152 billion in interest to credit institutions starting in June 2023, on an annual basis, and the Fed will pay $162 billion.

5 Describing this transfer as a « subsidy » requires clarification. As Warren Mosler himself points out, it is not, for the most part, a direct donation to bankers, but a transfer to depositors. He specifies that this impact depends on the intensity of competition in the banking market. The criticism therefore focuses less on the ultimate beneficiary than on the very nature of this opaque and undiscussed redistribution policy.

6. Issued by the central bank without creating debt (no securities or bank loans), this currency differs from standard bank money. It would be injected via a dedicated public institution (often called the « Sustainable Development Fund ») that would finance targeted subsidies: thermal renovation, rural infrastructure, biocorridors, public institutions, etc.

7. This would be a currency created ex nihilo by the central bank, but not backed by traditional public debt (no sale of bonds to the financial markets)