I get that IoR is contractionary and it makes perfect sense to me. What I am looking for is what impact it has between shadow banking and the formal banking system. I read a Fed working paper describing the rationale for IoR and it contained the following factors:

  1. Lack of demand for reserves results in loss of control over monetary policy
  2. Adjusting the rate of IOR allows for fine tuning of monetary policy

The question I have is: do either of these things really matter if looking at the banking system from a free market perspective? What is the benefit to having less liquidity in the shadow banking system and gobs of reserves in the formal system? I would guess that the only real difference is from the regulatory and central planning perspective, but I might be missing something somewhere because I don’t know that much about the details of the banking system.

Any help in understanding it is appreciated.

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