The Optimal Conduct of Monetary Policy with Interest on Reserves

31 Pages Posted: 30 Jun 2011 Last revised: 4 Apr 2013

Anil K. Kashyap

University of Chicago, Booth School of Business; National Bureau of Economic Research (NBER); Federal Reserve Bank of Chicago

Jeremy C. Stein

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: June 29, 2011

Abstract

In a world with interest on reserves, the central bank has two distinct tools that it can use to raise the short-term policy rate: it can either increase the interest it pays on reserve balances, or it can reduce the quantity of reserves in the system. We argue that by using both of these tools together, and by broadening the scope of reserve requirements, the central bank can simultaneously pursue two objectives: i) it can manage the inflation-output tradeoff using a Taylor-type rule; and ii) it can regulate the externalities created by socially excessive short-term debt issuance on the part of financial intermediaries.

Suggested Citation

Kashyap, Anil K. and Stein, Jeremy C., The Optimal Conduct of Monetary Policy with Interest on Reserves (June 29, 2011). Chicago Booth Research Paper No. 11-20; Fama-Miller Working Paper. Available at SSRN: https://ssrn.com/abstract=1874838 or http://dx.doi.org/10.2139/ssrn.1874838

Anil K. Kashyap (Contact Author)

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Jeremy C. Stein

Harvard University - Department of Economics ( email )

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