'Excess Reserves, Monetary Policy and Financial Volatility
AbstractThis paper examines the financial and real effects of excess reserves in a New Keynesian Dynamic Stochastic General Equilibrium (DSGE) model with monopoly banking, credit market imperfections and a cost channel. The model explicitly accounts for the fact that banks hold excess reserves and they incur costs in holding these assets. Simulations of a shock to required reserves show that although raising reserve requirements is successful in sterilizing excess reserves, it creates a procyclical effect for real economic activity. This result implies that financial stability may come at a cost of macroeconomic stability. The findings also indicate that using an augmented Taylor rule in which the policy interest rate is adjusted in response to changes in excess reserves reduces volatility in output and inflation but increases fluctuations in financial variables. To the contrary, using a countercyclical reserve requirement rule helps to mitigate fluctuations in excess reserves, but increases volatility in real variables.
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Bibliographic InfoPaper provided by Economics, The Univeristy of Manchester in its series Centre for Growth and Business Cycle Research Discussion Paper Series with number 183.
Length: 58 pages
Date of creation: 2013
Date of revision:
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This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-05-19 (All new papers)
- NEP-BAN-2013-05-19 (Banking)
- NEP-CBA-2013-05-19 (Central Banking)
- NEP-DGE-2013-05-19 (Dynamic General Equilibrium)
- NEP-MAC-2013-05-19 (Macroeconomics)
- NEP-MON-2013-05-19 (Monetary Economics)
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