The cerebral cholinergic system is centrally involved in memory formation. Studies in rodents suggest that cholinergic stimulation may facilitate encoding of new information but may interfere with retrieval. We investigated the effect of cholinergic stimulation on encoding and retrieval of episodic memory in humans. We also tested whether the putative benefit of cholinergic stimulation on memory function depends on individual baseline performance. Since such effects were expected to be greatest in an older population resulting from an age-related degeneration of the cholinergic system, we recruited 22 healthy older subjects (51-68 years) for an event-related functional magnetic resonance imaging experiment. In two separate scanning sessions, subjects encoded and retrieved items and their spatial context under cholinergic stimulation or placebo with the acetylcholine-esterase inhibitor physostigmine or saline being administered intravenously in a double-blind cross-over design. Baseline performance was recorded at a separate occasion without scanning. Cholinergic stimulation enhanced neural activity for successful versus unsuccessful spatial context encoding in the right hippocampus but reduced activity for successful versus unsuccessful spatial context retrieval in the right amygdala. These data may bridge the gap between rodent and human studies by showing that also in man cholinergic stimulation enhances encoding but interferes with retrieval on a neural level. Furthermore, baseline performance negatively correlated with the effect of cholinergic stimulation. Thus, participants who were worse at baseline benefited more from cholinergic stimulation than those who had better baseline values, indicating that a cholinergic deficit contributes to the memory decline even in healthy older subjects.