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Speculative Runs on Interest Rate Pegs

  • Marco Bassetto
  • Christopher Phelan

We analyze a new class of equilibria that emerges when a central bank conducts monetary policy by setting an interest rate (as an arbitrary function of its available information) and letting the private sector set the quantity traded. These equilibria involve a run on the central bank's interest target, whereby money grows fast, private agents borrow as much as possible against the central bank, and the shadow interest rate is different from the policy target. We argue that these equilibria represent a particular danger when banks hold large excess reserves, such as is the case following periods of quantitative easing. Our analysis suggests that successfully managing the exit strategy requires additional tools beyond setting interest-rate targets and paying interest on reserves; in particular, freezing excess reserves or fiscal-policy intervention may be needed to fend off adverse expectations.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 18864.

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Date of creation: Mar 2013
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Publication status: published as Journal of Monetary Economics Volume 73, July 2015, Pages 99–114 Carnegie-Rochester-NYU Conference Series on Public Policy “Monetary Policy: An Unprecedented Predicament” held at the Tepper School of Business, Carnegie Mellon University, November 14-15, 2014 Cover image Speculative runs on interest rate pegs Marco Bassettoa, b, c, , , Christopher Pheland, e, f,
Handle: RePEc:nbr:nberwo:18864
Note: EFG ME
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  17. Sargent, Thomas J & Wallace, Neil, 1975. ""Rational" Expectations, the Optimal Monetary Instrument, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 83(2), pages 241-54, April.
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