Scott Freeman (Department of Economics, University of Texas-Austin, Austin, TX 78712, USA) Joseph H. Haslag (Research Department, Federal Reserve Bank of Dallas, Dallas, TX 75201, USA, and Department of Economics, Southern Methodist University, 75275, USA)
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Paying interest on required reserves is considered in an overlapping generations model in which the return to capital dominates the return to fiat money. As Smith (1991) showed, financing interest on reserves benefits the initial old at the expense of future generations. We show that the transfer of wealth associated with interest on reserves can be offset by an accommodating open market purchase, so that the payment of interest on reserves is a Pareto improvement. We also show that paying interest on reserves improves welfare even when financed by distorting taxes on capital.
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Article provided by Springer in its journal Economic Theory.
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