Fiscal Consequences of Paying Interest on Reserves

35 Pages Posted: 8 Jun 2013

See all articles by Marco Bassetto

Marco Bassetto

Federal Reserve Bank of Chicago

Todd Messer

Federal Reserve Board

Date Written: June 6, 2013


We review the role of the central bank's (CB) balance sheet in a textbook monetary model, and explore what changes if the central bank is allowed to pay interest on its liabilities. When the central bank cannot pay interest, away from the zero lower bound its (real) balance sheet is limited by the demand for money. Furthermore, if securities are not marked to market and the central bank holds its bonds to maturity, it is impossible for the central bank to make losses, and it always obtains pro ts from being a monopoly provider of money. When the option of paying interest on liabilities is allowed, the limit on the CB's balance sheet is lifted. In this case, the CB is free to take on interest rate risk, e.g, by buying long-term securities and financing those purchases with short-term debt that pays the market interest rate. This is a risky enterprise that can lead to additional profits but also to losses. To the extent that losses exceed the profits of the monopoly operations, the CB faces two options: either it is recapitalized by Treasury, or it increases its monopoly profits by raising the inflation tax.

Keywords: Interest on Reserves, Central Bank, Fiscal Risk

JEL Classification: E63, H63

Suggested Citation

Bassetto, Marco and Messer, Todd, Fiscal Consequences of Paying Interest on Reserves (June 6, 2013). FRB of Chicago Working Paper No. 2013-04, Available at SSRN: or

Marco Bassetto (Contact Author)

Federal Reserve Bank of Chicago ( email )

230 South LaSalle Street
Chicago, IL 60604
United States

Todd Messer

Federal Reserve Board ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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