Interest On Reserves And Sunspot Equilibria: Friedman'S Proposal Reconsidered
M. Friedman's (1960) proposal to pay interest on (required) reserves is considered in a setting that eliminates the indeterminacy of steady-state equilibrium discussed by T. J. Sargent and N. Wallace (1985). In an overlapping-generations model where the real rate of interest is technologically determined, the payment of interest on reserves results in a determinate, Pareto optimal steady-state equilibrium. However, interest payments on reserves reduce the steady-state welfare of all young agents and, for many economies, results in the existence of stationary sunspot equilibria. This is the case even if such equilibria cannot exist when reserves do not earn interest. Copyright 1991 by The Review of Economic Studies Limited.
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