The Macroeconomic Effects of Interest on Reserves

This paper uses a New Keynesian model with banks and deposits, calibrated to match the US economy, to study the macroeconomic effects of policies that pay interest on reserves. While their effects on output and inflation are small, these policies require important adjustments in the way that the monetary authority manages the supply of reserves, as liquidity effects vanish and households’ portfolio shifts increase banks’ demand for reserves when short-term interest rates rise. Money and monetary policy remain linked in the long run, however, since policy actions that change the price level must change the supply of reserves proportionately. JEL: E31, E32, E51, E52, E58. ∗Please address correspondence to: Peter N. Ireland, Boston College, Department of Economics, 140 Commonwealth Avenue, Chestnut Hill, MA 02467-3859 USA. Tel: (617) 552-3687. Fax: (617) 552-2308. Email: [email protected]. http://www2.bc.edu/peter-ireland. The opinions, findings, conclusions, and recommendations expressed herein are my own and do not reflect those of the National Bureau of Economic Research.