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Monetary policy with interest on reserves

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  • Andreas Hornstein

Abstract

Since the fall of 2008, the amount of outstanding reserves on the Federal Reserve's balance sheet has increased from about 100 billion dollars to more than 1 trillion dollars. There is some concern that the magnitude of outstanding reserves might affect the ability of the Federal Reserve to conduct monetary policy through an interest rate policy. In this article I argue that the ability of the Federal Reserve to pay interest on reserves, also introduced in the fall of 2008, should lessen this concern. For an appropriately modified baseline model of money, I show that, with the payment of interest on reserves, the interaction of monetary and fiscal policy in the determination of the price level is not affected in a quantitatively meaningful way by the amount of outstanding reserves.

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Bibliographic Info

Article provided by Federal Reserve Bank of Richmond in its journal Economic Quarterly.

Volume (Year): (2010)
Issue (Month): 2Q ()
Pages: 153-177

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Handle: RePEc:fip:fedreq:y:2010:i:2q:p:153-177:n:vol.96no.2

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Related research

Keywords: Inflation (Finance) ; Monetary policy;

References

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  1. Matthew Canzoneri & Robert Cumby & Behzad Diba & David López-Salido, 2008. "Monetary aggregates and liquidity in a neo-Wicksellian framework," Working Paper Research 141, National Bank of Belgium.
  2. Huberto M. Ennis & Todd Keister, 2008. "Understanding monetary policy implementation," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 235-263.
  3. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 129-147, February.
  4. Bech, Morten L. & Klee, Elizabeth, 2011. "The mechanics of a graceful exit: Interest on reserves and segmentation in the federal funds market," Journal of Monetary Economics, Elsevier, vol. 58(5), pages 415-431.
  5. Huberto M. Ennis & John A. Weinberg, 2007. "Interest on reserves and daylight credit," Economic Quarterly, Federal Reserve Bank of Richmond, issue Spr, pages 111-142.
  6. Todd Keister & Antoine Martin & James McAndrews, 2008. "Divorcing money from monetary policy," Economic Policy Review, Federal Reserve Bank of New York, issue Sep, pages 41-56.
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