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The Use of Reserve Requirements in an Optimal Monetary Policy Framework

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  • Hernando Vargas Herrera

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  • Pamela Cardozo

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    Abstract

    We analyse three models to determine the conditions under which reserve requirements are used as a part of an optimal monetary policy framework in an inflation targeting regime. In all cases the Central Bank (CB) minimizes an objective function that depends on deviations of inflation from its target, the output gap and deviations of reserve requirements from its optimal long term level. In a closed economy model we find that optimal monetary policy implies setting reserve requirements at their long term level, while adjusting the policy interest rate to face macroeconomic shocks. Reserve requirements are included in an optimal monetary policy response in an open economy model with the same CB objective function and in a closed economy model in which the CB objective function includes financial stability. The relevance, magnitude and direction of the movements of reserve requirements depend on the parameters of the economy and the shocks that affect it.

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    Bibliographic Info

    Paper provided by BANCO DE LA REPÚBLICA in its series BORRADORES DE ECONOMIA with number 009824.

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    Length: 20
    Date of creation: 15 Jul 2012
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    Handle: RePEc:col:000094:009824

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    Keywords: Reserve Requirements; Inflation Targeting; Monetary Policy.;

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    1. Hernando Vargas Herrera & Carlos Varela & Yanneth R. Betancourt & Norberto Rodríguez, 2010. "Effects of Reserve Requirements in an Inflation Targeting Regime: The Case of Colombia," BORRADORES DE ECONOMIA 006710, BANCO DE LA REPÚBLICA.
    2. Christian Glocker & Pascal Towbin, 2012. "The Macroeconomic Effects of Reserve Requirements," WIFO Working Papers 420, WIFO.
    3. Ben S. Bernanke & Alan S. Blinder, 1988. "Credit, Money, and Aggregate Demand," NBER Working Papers 2534, National Bureau of Economic Research, Inc.
    4. Rocío Betancourt & Hernando Vargas, 2009. "Encajes bancarios y tasas de interés," ENSAYOS SOBRE POLÍTICA ECONÓMICA, BANCO DE LA REPÚBLICA - ESPE.
    5. Reinhart, Carmen & Reinhart, Vincent, 1999. "On the use of reserve requirements in dealing with capital flow problems," MPRA Paper 13703, University Library of Munich, Germany.
    6. Glocker, C. & Towbin, P., 2012. "Reserve Requirements for Price and Financial Stability - When Are They Effective?," Working papers 363, Banque de France.
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    Cited by:
    1. Armas, Adrián & Castillo, Paul & Vega, Marco, 2014. "Inflation targeting and Quantitative Tightening: Effects of Reserve Requirements in Peru," Working Papers 2014-003, Banco Central de Reserva del Perú.

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