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Monetary policy with interest on reserves

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  • Cochrane, John H.

Abstract

I analyze monetary policy with interest on reserves and a large balance sheet. I show that conventional theories do not determine inflation in this regime, so I base the analysis on the fiscal theory of the price level. I find that monetary policy can peg the nominal rate, and determine expected inflation. With sticky prices, monetary policy can also affect real interest rates and output, though higher interest rates raise output and then inflation. The conventional sign requires a coordinated fiscal–monetary policy contraction. I show how conventional new-Keynesian models also imply strong monetary–fiscal policy coordination to obtain the usual signs. I address theoretical controversies. A concluding section places our current regime in a broader historical context, and opines on how optimal fiscal and monetary policy will evolve in the new regime.

Suggested Citation

  • Cochrane, John H., 2014. "Monetary policy with interest on reserves," Journal of Economic Dynamics and Control, Elsevier, vol. 49(C), pages 74-108.
  • Handle: RePEc:eee:dyncon:v:49:y:2014:i:c:p:74-108
    DOI: 10.1016/j.jedc.2014.09.003
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    More about this item

    Keywords

    Monetary policy; Interest on reserves; Balance sheet; Fiscal theory;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

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