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Pegging the interest rate on bank reserves: A resolution of New Keynesian puzzles and paradoxes

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  • Diba, Behzad
  • Loisel, Olivier

Abstract

Introducing bank reserves (or money) into the basic New Keynesian (NK) model offers a resolution of NK puzzles and paradoxes. The resulting models deliver local-equilibrium determinacy under an exogenous interest rate on reserves and an exogenous nominal stock of reserves, even for an arbitrarily small monetary friction. This leads to a resolution of the forward-guidance puzzle, the fiscal-multiplier puzzle, and the paradox of flexibility. As the monetary friction becomes vanishingly small, the models converge to the basic NK model and serve to select a particular equilibrium of that model - which also offers a resolution of the paradox of toil.

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  • Diba, Behzad & Loisel, Olivier, 2021. "Pegging the interest rate on bank reserves: A resolution of New Keynesian puzzles and paradoxes," Journal of Monetary Economics, Elsevier, vol. 118(C), pages 230-244.
    • Handle: RePEc:eee:moneco:v:118:y:2021:i:c:p:230-244
    DOI: 10.1016/j.jmoneco.2020.10.002
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    Cited by:

    1. Guido Ascari & Sophocles Mavroeidis & Nigel McClung, 2023. "Coherence without Rationality at the ZLB," DEM Working Papers Series 212, University of Pavia, Department of Economics and Management.
    2. Bonciani, Dario & Oh, Joonseok, 2023. "Revisiting the New Keynesian policy paradoxes under QE," European Economic Review, Elsevier, vol. 154(C).
    3. He Nie & Jordan Roulleau-Pasdeloup, 2023. "The promises (and perils) of control-contingent forward guidance," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 49, pages 77-98, July.
    4. Haderer, Michaela, 2022. "An Estimated DSGE Model of the Euro Area with Expectations about the Timing and Nature of Liftoff from the Lower Bound," Working Papers 2022-05, University of Sydney, School of Economics.
    5. Pascal Michaillat & Emmanuel Saez, 2021. "Resolving New Keynesian Anomalies with Wealth in the Utility Function," The Review of Economics and Statistics, MIT Press, vol. 103(2), pages 197-215, May.
    6. Christopher Gibbs & Nigel McClung, 2023. "Does my model predict a forward guidance puzzle?," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 51, pages 393-423, December.
    7. Matthew Canzoneri & Robert Cumby & Behzad Diba & Yunsang Kim, 2021. "Did the Unconventional Monetary Policy of the U.S. Hurt Emerging Markets?," Open Economies Review, Springer, vol. 32(2), pages 231-257, April.
    8. Böhl, Gregor, 2022. "Endogenous Money, Excess Reserves and Unconventional Monetary Policy," VfS Annual Conference 2022 (Basel): Big Data in Economics 264141, Verein für Socialpolitik / German Economic Association.
    9. Christopher Gibbs & Nigel McClung, 2023. "Does my model predict a forward guidance puzzle?," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 51, pages 393-423, December.
    10. Christian Bredemeier & Falko Juessen & Andreas Schabert, 2021. "Why Are Fiscal Multipliers Moderate Even Under Monetary Accommodation?," ECONtribute Discussion Papers Series 074, University of Bonn and University of Cologne, Germany.
    11. Eskelinen, Maria & Gibbs, Christopher G. & McClung, Nigel, 2024. "Resolving new keynesian puzzles," Bank of Finland Research Discussion Papers 5/2024, Bank of Finland.
    12. Guillermo Calvo & Andrés Velasco, 2021. "Joined at the hip: monetary and fiscal policy in a liquidity-dependent world," BIS Working Papers 967, Bank for International Settlements.
    13. Lu, You-Xun, 2022. "The stabilizing effect of the zero lower bound: A perspective of interest rate target zones," The Quarterly Review of Economics and Finance, Elsevier, vol. 84(C), pages 61-67.

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    More about this item

    Keywords

    Forward-guidance puzzle; Fiscal-multiplier puzzle; Paradox of flexibility; Paradox of toil; Interest rate on reserves;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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