Speculative Runs on Interest Rate Pegs

39 Pages Posted: 9 Mar 2013

See all articles by Marco Bassetto

Marco Bassetto

Federal Reserve Bank of Chicago

Christopher Phelan

Federal Reserve Bank of Minneapolis

Date Written: March 2013

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.

Suggested Citation

Bassetto, Marco and Phelan, Christopher J., Speculative Runs on Interest Rate Pegs (March 2013). Available at SSRN: https://ssrn.com/abstract=2230754

Marco Bassetto (Contact Author)

Federal Reserve Bank of Chicago ( email )

230 South LaSalle Street
Chicago, IL 60604
United States

Christopher J. Phelan

Federal Reserve Bank of Minneapolis ( email )

90 Hennepin Avenue
Minneapolis, MN 55480
United States
612-204-5615 (Phone)

HOME PAGE: http://phelan.mpls.frb.fed.us

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
11
Abstract Views
376
PlumX Metrics