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Pegging the interest rate on bank reserves: A resolution of New Keynesian puzzles and paradoxes

Behzad Diba and Olivier Loisel

Journal of Monetary Economics, 2021, vol. 118, issue C, 230-244

Abstract: Introducing bank reserves (or money) into the basic New Keynesian (NK) model offers a resolution of NK puzzles and paradoxes. The resulting models deliver local-equilibrium determinacy under an exogenous interest rate on reserves and an exogenous nominal stock of reserves, even for an arbitrarily small monetary friction. This leads to a resolution of the forward-guidance puzzle, the fiscal-multiplier puzzle, and the paradox of flexibility. As the monetary friction becomes vanishingly small, the models converge to the basic NK model and serve to select a particular equilibrium of that model - which also offers a resolution of the paradox of toil.

Keywords: Forward-guidance puzzle; Fiscal-multiplier puzzle; Paradox of flexibility; Paradox of toil; Interest rate on reserves (search for similar items in EconPapers)
JEL-codes: E52 E58 (search for similar items in EconPapers)
Date: 2021
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Working Paper: Pegging the Interest Rate on Bank Reserves: A Resolution of New Keynesian Puzzles and Paradoxes (2019) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:eee:moneco:v:118:y:2021:i:c:p:230-244

DOI: 10.1016/j.jmoneco.2020.10.002

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