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'Excess Reserves, Monetary Policy and Financial Volatility

  • Keyra Primus
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    This paper examines the financial and real effects of excess reserves in a New Keynesian Dynamic Stochastic General Equilibrium (DSGE) model with monopoly banking, credit market imperfections and a cost channel. The model explicitly accounts for the fact that banks hold excess reserves and they incur costs in holding these assets. Simulations of a shock to required reserves show that although raising reserve requirements is successful in sterilizing excess reserves, it creates a procyclical effect for real economic activity. This result implies that financial stability may come at a cost of macroeconomic stability. The findings also indicate that using an augmented Taylor rule in which the policy interest rate is adjusted in response to changes in excess reserves reduces volatility in output and inflation but increases fluctuations in financial variables. To the contrary, using a countercyclical reserve requirement rule helps to mitigate fluctuations in excess reserves, but increases volatility in real variables.

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    File URL: http://www.socialsciences.manchester.ac.uk/medialibrary/cgbcr/discussionpapers/dpcgbcr183.pdf
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    Paper provided by Economics, The Univeristy of Manchester in its series Centre for Growth and Business Cycle Research Discussion Paper Series with number 183.

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    Length: 58 pages
    Date of creation: 2013
    Date of revision:
    Handle: RePEc:man:cgbcrp:183
    Contact details of provider: Postal: Manchester M13 9PL
    Phone: (0)161 275 4868
    Fax: (0)161 275 4812
    Web page: http://www.socialsciences.manchester.ac.uk/subjects/economics/our-research/centre-for-growth-and-business-cycle-research/

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    1. Christian Glocker & Pascal Towbin, 2012. "Reserve Requirements for Price and Financial Stability: When Are They Effective?," International Journal of Central Banking, International Journal of Central Banking, vol. 8(1), pages 65-114, March.
    2. Pierre-Richard Agénor & K. Alper & Luiz A. Pereira da Silva, 2011. "Capital Regulation, Monetary Policy and Financial Stability," Working Papers Series 237, Central Bank of Brazil, Research Department.
    3. Pierre-Richard Agénor & Koray Alper, 2009. "Monetary Shocks and Central Bank Liquidity with Credit Market Imperfections," Centre for Growth and Business Cycle Research Discussion Paper Series 120, Economics, The Univeristy of Manchester.
    4. Malikane, Christopher, 2012. "Inflation dynamics and the cost channel in emerging markets," MPRA Paper 42688, University Library of Munich, Germany.
    5. International Monetary Fund, 2012. "Credit Growth and the Effectiveness of Reserve Requirements and Other Macroprudential Instruments in Latin America," IMF Working Papers 12/142, International Monetary Fund.
    6. 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.
    7. Agénor, Pierre-Richard & Aynaoui, Karim El, 2010. "Excess liquidity, bank pricing rules, and monetary policy," Journal of Banking & Finance, Elsevier, vol. 34(5), pages 923-933, May.
    8. Carlos Montoro & Ramon Moreno, 2011. "The use of reserve requirements as a policy instrument in Latin America," BIS Quarterly Review, Bank for International Settlements, March.
    9. Waldyr Dutra Areosa & Christiano Arrigoni Coelho, 2013. "Using a DSGE Model to Assess the Macroeconomic Effects of Reserve Requirements in Brazil," Working Papers Series 303, Central Bank of Brazil, Research Department.
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