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Floor systems and the Friedman rule: the fiscal arithmetic of open market operations

Author

Listed:
  • Keister, Todd

    (Rutgers University and Paris School of Economics)

  • Martin, Antoine

    (Federal Reserve Bank of New York)

  • McAndrews, James J.

    (Federal Reserve Bank of New York)

Abstract

In a floor system of monetary policy implementation, the central bank remunerates bank reserves at or near the market rate of interest. Some observers have expressed concern that operating such a system will have adverse fiscal consequences for the public sector and may even require the government to subsidize the central bank. We show that this is not the case. Using the monetary general equilibrium model of Berentsen et al. (2014), we show how a central bank that supplies reserves through open market operations can always generate non-negative net income, even when using a floor system to implement the Friedman rule.

Suggested Citation

  • Keister, Todd & Martin, Antoine & McAndrews, James J., 2015. "Floor systems and the Friedman rule: the fiscal arithmetic of open market operations," Staff Reports 754, Federal Reserve Bank of New York.
    • Handle: RePEc:fip:fednsr:754
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    References listed on IDEAS

    as
    1. Todd Keister & James J. McAndrews, 2009. "Why are banks holding so many excess reserves?," Current Issues in Economics and Finance, Federal Reserve Bank of New York, vol. 15(Dec).
    2. Chari, V. V. & Christiano, Lawrence J. & Kehoe, Patrick J., 1996. "Optimality of the Friedman rule in economies with distorting taxes," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 203-223, April.
    3. Marvin Goodfriend, 2002. "Interest on reserves and monetary policy," Economic Policy Review, Federal Reserve Bank of New York, issue May, pages 77-84.
    4. Ricardo Lagos & Randall Wright, 2005. "A Unified Framework for Monetary Theory and Policy Analysis," Journal of Political Economy, University of Chicago Press, vol. 113(3), pages 463-484, June.
    5. Joseph E. Gagnon & Brian Sack, 2014. "Monetary Policy with Abundant Liquidity: A New Operating Framework for the Fed," Policy Briefs PB14-4, Peterson Institute for International Economics.
    6. Christensen, Jens H.E. & Lopez, Jose A. & Rudebusch, Glenn D., 2015. "A probability-based stress test of Federal Reserve assets and income," Journal of Monetary Economics, Elsevier, vol. 73(C), pages 26-43.
    7. Del Negro, Marco & Sims, Christopher A., 2015. "When does a central bank׳s balance sheet require fiscal support?," Journal of Monetary Economics, Elsevier, vol. 73(C), pages 1-19.
    8. Seth Carpenter & Jane Ihrig & Elizabeth Klee & Daniel Quinn & Alexander Boote, 2015. "The Federal Reserve's Balance Sheet and Earnings: A Primer and Projections," International Journal of Central Banking, International Journal of Central Banking, vol. 11(2), pages 237-283, March.
    9. Berentsen, Aleksander & Monnet, Cyril, 2008. "Monetary policy in a channel system," Journal of Monetary Economics, Elsevier, vol. 55(6), pages 1067-1080, September.
    10. Marco Bassetto & Todd Messer, 2013. "Fiscal Consequences of Paying Interest on Reserves," Fiscal Studies, Institute for Fiscal Studies, vol. 34, pages 413-436, December.
    11. Ennis, Huberto M., 2018. "A simple general equilibrium model of large excess reserves," Journal of Monetary Economics, Elsevier, vol. 98(C), pages 50-65.
    12. Javier Bianchi & Saki Bigio, 2014. "Banks, Liquidity Management and Monetary Policy," Working Papers 2014-18, Peruvian Economic Association.
    13. Aleksander Berentsen & Alessandro Marchesiani & Christopher Waller, 2014. "Floor Systems for Implementing Monetary Policy: Some Unpleasant Fiscal Arithmetic," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 17(3), pages 523-542, July.
    14. David Bowman & Etienne Gagnon & Michael P. Leahy, 2010. "Interest on excess reserves as a monetary policy instrument: the experience of foreign central banks," International Finance Discussion Papers 996, Board of Governors of the Federal Reserve System (U.S.).
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    More about this item

    Keywords

    monetary policy implementation; central bank operations; interest on reserves;

    JEL classification:

    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • 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

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