The impact of paying interest on reserves in the presence of government deficit financing

Mark Guzman

No 406, Working Papers from Federal Reserve Bank of Dallas

Abstract: This paper re-examines the impact that paying interest on reserves has on price level indeterminacy, price level volatility, and overall economic well-being. Unlike previous papers which examined these issues, the model developed in this paper allows the return on reserves to equal the return on government securities, which is less than the prevailing return on storage. Equally important, this model also considers how deficit financing changes the impact that paying interest on reserves has on the economy. I show that the number of steady state equilibria are equal to, or greater than, the number that arise when no interest is paid on reserves. In other words, the level of economic indeterminacy is equal to or greater than in an economy without interest payments. When the level of indeterminacy is the same, then economic volatility is reduced with the introduction of interest payments. However, when there exists greater indeterminacy in the interest-on-reserves economy, then there also exists greater volatility. In addition, under certain conditions, paying interest on reserves can be welfare enhancing. When it is not, an appropriate expansionary open market operation can offset the welfare losses associated with interest payments. Finally, under a narrow set of conditions, unpleasant monetarist arithmetic may obtain.

Keywords: Bank reserves; Interest (search for similar items in EconPapers)
Pages: 32 pages
Date: 2004
New Economics Papers: this item is included in nep-mon
Note: Published as: Guzman, Mark G. (2008), "The Impact of Paying Interest on Reserves in the Presence of Government Deficit Financing," Economic Inquiry 46 (4): 624-642.
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Related works:
Journal Article: THE IMPACT OF PAYING INTEREST ON RESERVES IN THE PRESENCE OF GOVERNMENT DEFICIT FINANCING (2008)
Working Paper: The Impact of Paying Interest on Reserves in the Presence of Government Deficit Financing (2007)
Working Paper: The impact of paying interest on reserves in the presence of government deficit financing (2006)
Working Paper: The impact of paying interest on reserves in the presence of government deficit financing (2006)
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