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Monetary policy with interest on reserves

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  • Andreas Hornstein

Abstract

Since the fall of 2008, the amount of outstanding reserves on the Federal Reserve's balance sheet has increased from about 100 billion dollars to more than 1 trillion dollars. There is some concern that the magnitude of outstanding reserves might affect the ability of the Federal Reserve to conduct monetary policy through an interest rate policy. In this article I argue that the ability of the Federal Reserve to pay interest on reserves, also introduced in the fall of 2008, should lessen this concern. For an appropriately modified baseline model of money, I show that, with the payment of interest on reserves, the interaction of monetary and fiscal policy in the determination of the price level is not affected in a quantitatively meaningful way by the amount of outstanding reserves.

Suggested Citation

  • Andreas Hornstein, 2010. "Monetary policy with interest on reserves," Economic Quarterly, Federal Reserve Bank of Richmond, issue 2Q, pages 153-177.
  • Handle: RePEc:fip:fedreq:y:2010:i:2q:p:153-177:n:v.96no.2
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    References listed on IDEAS

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    1. Matthew Canzoneri & Robert Cumby & Behzad Diba & David Lãpez-Salido, 2008. "Monetary Aggregates and Liquidity in a Neo-Wicksellian Framework," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(8), pages 1667-1698, December.
    2. Bruce D. Smith, 1991. "Interest on Reserves and Sunspot Equilibria: Friedman's Proposal Reconsidered," Review of Economic Studies, Oxford University Press, vol. 58(1), pages 93-105.
    3. Huberto M. Ennis & John A. Weinberg, 2007. "Interest on reserves and daylight credit," Economic Quarterly, Federal Reserve Bank of Richmond, issue Spr, pages 111-142.
    4. Woodford, Michael, 2000. "Monetary Policy in a World without Money," International Finance, Wiley Blackwell, vol. 3(2), pages 229-260, July.
    5. Goodfriend, Marvin & McCallum, Bennett T., 2007. "Banking and interest rates in monetary policy analysis: A quantitative exploration," Journal of Monetary Economics, Elsevier, vol. 54(5), pages 1480-1507, July.
    6. Huberto M. Ennis & Todd Keister, 2008. "Understanding monetary policy implementation," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 235-263.
    7. Todd Keister & Antoine Martin & James J. McAndrews, 2008. "Divorcing money from monetary policy," Economic Policy Review, Federal Reserve Bank of New York, issue Sep, pages 41-56.
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    Cited by:

    1. Homburg, Stefan, 2017. "A Study in Monetary Macroeconomics," OUP Catalogue, Oxford University Press, number 9780198807537.
    2. Chang, Su-Hsin & Contessi, Silvio & Francis, Johanna L., 2014. "Understanding the accumulation of bank and thrift reserves during the U.S. financial crisis," Journal of Economic Dynamics and Control, Elsevier, vol. 43(C), pages 78-106.

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    Keywords

    Inflation (Finance) ; Monetary policy;

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