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The Impact Of Paying Interest On Reserves In The Presence Of Government Deficit Financing

  • MARK G. GUZMAN

"This paper reexamines the impact that paying interest on reserves has on price level indeterminacy, volatility, and economic well-being. Unlike the previous literature, this model includes an after-tax deficit financed by assets (bonds and reserves) whose returns are linked. I show that the number of steady-state equilibria and the corresponding level of indeterminacy are equal to, or greater than, those arising in the no-interest economy. When the level of indeterminacy is the same, the economic volatility is reduced by paying interest. However, greater indeterminacy in the interest economy results in greater volatility. Finally, paying interest on reserves can enhance welfare". ("JEL "D6, E3, E5) Copyright (c) 2008 Western Economic Association International.

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Article provided by Western Economic Association International in its journal Economic Inquiry.

Volume (Year): 46 (2008)
Issue (Month): 4 (October)
Pages: 624-642

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Handle: RePEc:bla:ecinqu:v:46:y:2008:i:4:p:624-642
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  1. Scott Freeman & Joseph H. Haslag, 1993. "On the optimality of interest-bearing reserves in economies of overlapping generations," Research Paper 9328, Federal Reserve Bank of Dallas.
  2. Charles Goodhart, 2000. "Can Central Banking Survive the IT Revolution?," FMG Special Papers sp125, Financial Markets Group.
  3. Neil Wallace, 1984. "Some of the choices for monetary policy," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win.
  4. Marco Espinosa & Steven Russell, 1998. "Can a Policy of Higher Inflation Reduce Real Interests in the Long Run?," Canadian Journal of Economics, Canadian Economics Association, vol. 31(1), pages 92-103, February.
  5. Goodhart, Charles A E, 2000. "Can Central Banking Survive the IT Revolution?," International Finance, Wiley Blackwell, vol. 3(2), pages 189-209, July.
  6. Hall Robert, 2002. "Controlling the Price Level," The B.E. Journal of Macroeconomics, De Gruyter, vol. 2(1), pages 1-21, July.
  7. Jeffrey M. Lacker, 1997. "Clearing, settlement, and monetary policy," Working Paper 97-01, Federal Reserve Bank of Richmond.
  8. Mark Toma, 1999. "A Positive Model of Reserve Requirements and Interest on Reserves: A Clearinghouse Interpretation of the Federal Reserve System," Southern Economic Journal, Southern Economic Association, vol. 66(1), pages 101-116, July.
  9. Smith, Bruce D, 1991. "Interest on Reserves and Sunspot Equilibria: Friedman's Proposal Reconsidered," Review of Economic Studies, Wiley Blackwell, vol. 58(1), pages 93-105, January.
  10. Bhattacharya, Joydeep & Guzman, Mark G. & Smith, Bruce D., 1998. "Some Even More Unpleasant Monetarist Arithmetic," Staff General Research Papers 5084, Iowa State University, Department of Economics.
  11. Marvin Goodfriend, 2002. "Interest on reserves and monetary policy," Economic Policy Review, Federal Reserve Bank of New York, issue May, pages 77-84.
  12. Sargent, Thomas & Wallace, Neil, 1985. "Interest on reserves," Journal of Monetary Economics, Elsevier, vol. 15(3), pages 279-290, May.
  13. Gale, David, 1973. "Pure exchange equilibrium of dynamic economic models," Journal of Economic Theory, Elsevier, vol. 6(1), pages 12-36, February.
  14. Bruce D. Smith, 1984. "Money and inflation in colonial Massachusetts," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win.
  15. Dwyer, Gerald Jr. & Saving, Thomas R., 1986. "Government revenue from money creation with government and private money," Journal of Monetary Economics, Elsevier, vol. 17(2), pages 239-249, March.
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