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Excess Bank Reserves and Monetary Policy with a Lower-Bound Lending Rate September 2011

Author

Listed:
  • Tarron Khemraj

    (New College of Florida)

  • Christian R. Proaño

    () (Department of Economics, New School for Social Research)

Abstract

The paper posits the existence of a minimum mark-up loan interest rate threshold, which is identified using a long-term bank demand curve for excess reserves. At the threshold rate, the risk adjusted marginal revenue is equal to the marginal cost of extending loans. An excess reserves-loan (RL) equationis proposed to link excess reserves and aggregate output. The RL equation is combined with an IS equation, emphasizing the loan rate rather than the government bond rate. Together with a Phillips curve, the model is solved recursively to obtain equilibrium output and price level. The theoretical framework allows us to determine whether the unprecedented expansion of bank reserves by the Federal Reserve will engender inflation, deflation, hyperinflation or a deflationary spiral. The final outcome depends on a linear combination of five parameters and two probability regimes. The empirical results tend to support a deflation instead of an inflation regime.

Suggested Citation

  • Tarron Khemraj & Christian R. Proaño, 2011. "Excess Bank Reserves and Monetary Policy with a Lower-Bound Lending Rate September 2011," Working Papers 1104, New School for Social Research, Department of Economics.
  • Handle: RePEc:new:wpaper:1104
    as

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    File URL: http://www.economicpolicyresearch.org/econ/2011/NSSR_WP_042011.pdf
    File Function: First version, 2011
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    References listed on IDEAS

    as
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    5. Adam Ashcraft & James Mcandrews & David Skeie, 2011. "Precautionary Reserves and the Interbank Market," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 43(s2), pages 311-348, October.
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    12. Ferguson, J David & Hart, William R, 1980. "Liquidity Preference or Loanable Funds: Interest Rate Determination in Market Disequilibrium," Oxford Economic Papers, Oxford University Press, vol. 32(1), pages 57-70, March.
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    Cited by:

    1. Khemraj, Tarron, 2011. "The Non-Zero Lower Bound Lending Rate and the Liquidity Trap," MPRA Paper 42030, University Library of Munich, Germany, revised 01 May 2012.

    More about this item

    Keywords

    Excess reserves; quantitative easing; liquidity preference; deflation;

    JEL classification:

    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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