Speculative Runs on Interest Rate Pegs

Marco Bassetto and Christopher Phelan

No 18864, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: 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.

JEL-codes: E42 E43 E52 E61 (search for similar items in EconPapers)
Date: 2013-03
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
Note: EFG ME
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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,

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Journal Article: Speculative runs on interest rate pegs (2015)
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