Final answer:
The Fed began paying interest on excess reserves in 2008 in response to the financial crisis and the decrease in the federal funds rate, which by 2009 had fallen to 0.16%.
Step-by-step explanation:
The Fed started paying interest on excess reserves in 2008. The Fed began paying interest on excess reserves in 2008 in response to the financial crisis and the decrease in the federal funds rate, which by 2009 had fallen to 0.16%. This policy shift occurred as a response to the economic conditions of the time, particularly during the 2008-2009 recession.
The federal funds rate had dropped significantly from slightly above 5% in 2007 to 0.16% by 2009, and the Federal Reserve needed a mechanism to manage the economy given that interest rates were approaching zero and could not go negative. The payment of interest on excess reserves was an economic tool aimed at helping to control the money supply and to provide banks with an incentive to hold excess reserves, thus supporting financial stability.