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Pegging the Interest Rate on Bank Reserves


  • Diba Behzad

    (Department of Economics; Georgetown University)

  • Olivier Loisel



We develop a model of monetary policy with a small departure from the basic New Keynesian (NK) model. In this model, the central bank can set the interest rate on bank reserves and the nominal stock of bank reserves independently, because these reserves reduce the costs of banking (i.e., have a convenience yield). The model delivers local-equilibrium determinacy under a permanent interest-rate peg. Consequently, it does not share the puzzling and paradoxical implications of the basic NK model under a temporary peg (e.g., in the context of a liquidity trap). More specifically, it offers a resolution of the \forward guidance puzzle," a related puzzle about scal multipliers, and the \paradox of exibility," even for an arbitrarily small departure from the basic NK model (i.e., arbitrarily small banking costs and convenience yield of reserves).

Suggested Citation

  • Diba Behzad & Olivier Loisel, 2017. "Pegging the Interest Rate on Bank Reserves," Working Papers 2017-01, Center for Research in Economics and Statistics.
  • Handle: RePEc:crs:wpaper:2017-01

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    Cited by:

    1. Wu, Jing Cynthia & Zhang, Ji, 2019. "Global effective lower bound and unconventional monetary policy," Journal of International Economics, Elsevier, vol. 118(C), pages 200-216.
    2. Christian Bredemeier & Christoph Kaufmann & Andreas Schabert, 2017. "Interest Rate Spreads and Forward Guidance," Working Paper Series in Economics 96, University of Cologne, Department of Economics.
    3. Diba, Behzad & Loisel, Olivier, 2021. "Pegging the interest rate on bank reserves: A resolution of New Keynesian puzzles and paradoxes," Journal of Monetary Economics, Elsevier, vol. 118(C), pages 230-244.
    4. Bilbiie, Florin, 2018. "Monetary Policy and Heterogeneity: An Analytical Framework," CEPR Discussion Papers 12601, C.E.P.R. Discussion Papers.
    5. Roulleau-Pasdeloup, Jordan, 2020. "Optimal monetary policy and determinacy under active/passive regimes," European Economic Review, Elsevier, vol. 130(C).
    6. Nicolas Caramp & Dejanir Silva, 2019. "Fiscal Origins of Monetary Paradoxes," 2019 Meeting Papers 1281, Society for Economic Dynamics.

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