THE IMPACT OF PAYING INTEREST ON RESERVES IN THE PRESENCE OF GOVERNMENT DEFICIT FINANCING |
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| Authors: | MARK G. GUZMAN |
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| Affiliation: | 1. Guzman: Lecturer, Department of Economics, University of Reading, URS Building, PO Box 219, Whiteknights, Reading RG6 6AW, UK. Phone +44 (0) 118 378‐5080, Fax +44 (0) 118 378‐6533, E‐mail m.g.guzman@reading.ac.uk;2. I would like to thank Joe Haslag, Mark Wynne, and two anonymous referees for their helpful and insightful comments. Any errors are mine alone. |
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| Abstract: | This paper reexamines the impact that paying interest on reserves has on price level indeterminacy, volatility, and economic well‐being. Unlike the previous literature, this model includes an after‐tax deficit financed by assets (bonds and reserves) whose returns are linked. I show that the number of steady‐state equilibria and the corresponding level of indeterminacy are equal to, or greater than, those arising in the no‐interest economy. When the level of indeterminacy is the same, the economic volatility is reduced by paying interest. However, greater indeterminacy in the interest economy results in greater volatility. Finally, paying interest on reserves can enhance welfare. (JEL D6, E3, E5) |
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