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Is Reserve-ratio Arithmetic More Pleasant?

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  • Joydeep Bhattacharya
  • Joseph H. Haslag

Abstract

Does it matter in a revenue-neutral setting if the government changes the inflation tax base or the inflation tax rate? We answer this question within the context of an overlapping-generations model in which government bonds, capital and cash reserves coexist. We consider experiments that parallel those studied in Sargent and Wallace's 'unpleasant monetarist arithmetic'; the government uses seigniorage to service its debt, choosing between changing either the money growth rate (the inflation tax rate) or the reserve-requirement ratio (the inflation tax base). In the former case we obtain standard unpleasant arithmetic; in the long run a permanent open market sale results in higher money growth, and higher long-run inflation. Somewhat surprisingly, it turns out that, for a given money growth rate, lower reserve requirements fund the government's interest expense. Associated with the lower reserve requirements is lower long-run inflation and higher welfare, compared with the money-growth case. The broad message is that reserve-ratio arithmetic can be pleasant even when money-growth arithmetic is not. Copyright (c) The London School of Economics and Political Science 2003.

Suggested Citation

  • Joydeep Bhattacharya & Joseph H. Haslag, 2003. "Is Reserve-ratio Arithmetic More Pleasant?," Economica, London School of Economics and Political Science, vol. 70(279), pages 471-491, August.
  • Handle: RePEc:bla:econom:v:70:y:2003:i:279:p:471-491
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    Cited by:

    1. Barnett, Richard C., 2005. "Coordinating macroeconomic policy in a simple AK growth model," Journal of Macroeconomics, Elsevier, vol. 27(4), pages 621-647, December.
    2. Carrera, César, 2012. "Políticas de Encajes y Modelos Económicos," Working Papers 2012-006, Banco Central de Reserva del Perú.

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