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Optimal monetary policy with interest on reserves and capital over-accumulation

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  • Hu, Tai-Wei

Abstract

We propose a model where banks with limited liability issue deposits backed by capital, and households demand deposits and currency as means-of-payments for decentralized trades. When financial friction is severe or productivity is low, banks hold excess reserves in equilibrium with a low nominal interest rate, and with capital holdings above the efficient level. In that region, paying a positive interest on reserves financed by money creation is optimal. Under a fixed inflation target, optimal interest rate on reserves is procyclical. The constrained efficient allocation is implemented with a fixed and a proportional liquidity requirement in addition to interest on reserves when productivity is not too high.

Suggested Citation

  • Hu, Tai-Wei, 2021. "Optimal monetary policy with interest on reserves and capital over-accumulation," Journal of Economic Theory, Elsevier, vol. 196(C).
    • Handle: RePEc:eee:jetheo:v:196:y:2021:i:c:s0022053121001368
    DOI: 10.1016/j.jet.2021.105319
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    More about this item

    Keywords

    Monetary policy; Interest on reserves; Banking regulations;
    All these keywords.

    JEL classification:

    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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