Divorcing Money from Monetary Policy

16 Pages Posted: 2 Aug 2008

See all articles by Todd Keister

Todd Keister

Rutgers, The State University of New Jersey - Department of Economics

Antoine Martin

Federal Reserve Bank of New York - Research and Statistics

James McAndrews

Federal Reserve Bank of New York

Date Written: September 2008

Abstract

Many central banks implement monetary policy in a way that maintains a tight link between the stock of money and the short-term interest rate. In particular, their implementation procedures require that the supply of reserve balances be set precisely in order to implement the target interest rate. Because bank reserves play other key roles in the economy, this link can create tensions with other important objectives, especially in times of acute market stress. This article considers an alternative approach to monetary policy implementation - known as a "floor system"- that can reduce or even eliminate these tensions. The authors explain how this approach, in which the central bank pays interest on reserves at the target interest rate, "divorces" the supply of money from the conduct of monetary policy. The quantity of bank reserves can then be set according to the payment or liquidity needs of financial markets. By removing the opportunity cost of holding reserves, the floor system also encourages the efficient allocation of resources in the economy.

Keywords: monetary policy implementation, interest on reserves, daylight credit, liquidity policy

JEL Classification: E52, E58

Suggested Citation

Keister, Todd and Martin, Antoine and McAndrews, James, Divorcing Money from Monetary Policy (September 2008). Economic Policy Review, Vol. 14, No. 2, September 2008. Available at SSRN: https://ssrn.com/abstract=1195320 or http://dx.doi.org/10.2139/ssrn.1195320

Todd Keister (Contact Author)

Rutgers, The State University of New Jersey - Department of Economics ( email )

75 Hamilton Street
New Brunswick, NJ 08901
United States

HOME PAGE: http://econweb.rutgers.edu/tkeister

Antoine Martin

Federal Reserve Bank of New York - Research and Statistics ( email )

33 Liberty Street
New York, NY 10045
United States
212-720-6943 (Phone)

James McAndrews

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States
212-720-5063 (Phone)
212-720-8353 (Fax)

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