IDEAS home Printed from https://ideas.repec.org/p/boi/wpaper/2005.03.html
   My bibliography  Save this paper

Interest on Reserves and Inflation

Author

Listed:
  • Nissan Liviatan

    (Bank of Israel)

  • Roni Frish

    (Bank of Israel)

Abstract

The payment of interest on reserves was common practice in inflationary economies such as those in Latin America and Israel. This policy may appear as paradoxical since it implies returning part of the seigniorage that was generated by the inflation process, which presumably was initiated by the government in order to obtain inflationary finance for the deficit. In this paper we argue that the motivation for paying interest on reserves in the high inflation economies can be captured by the model of the discretionary regime, where the policymakers policies have to react to adverse expectations of the public (see Barro-Gordon 1983). In this environment the policymaker is concerned with the erosion of real liquidity by inflation, which is in part beyond his control, therefore he is willing to subsidize liquidity by paying interest on reserves. However, using the same analytical framework, we show that paying interest on reserves is an unlikely outcome for industrial economies, which are presumably closer to the rules (commitment) regime.

Suggested Citation

  • Nissan Liviatan & Roni Frish, 2005. "Interest on Reserves and Inflation," Bank of Israel Working Papers 2005.03, Bank of Israel.
    • Handle: RePEc:boi:wpaper:2005.03
    as

    Download full text from publisher

    File URL: https://boiwebrepec.azurefd.net/RePEc/boi/wpaper/WP_2005.03.pdf
    File Function: First version, 2005
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Barro, Robert J. & Gordon, David B., 1983. "Rules, discretion and reputation in a model of monetary policy," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 101-121.
    2. Chari, V. V. & Christiano, Lawrence J. & Kehoe, Patrick J., 1996. "Optimality of the Friedman rule in economies with distorting taxes," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 203-223, April.
    3. Isabel Correia & Pedro Teles, 1999. "The Optimal Inflation Tax," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 2(2), pages 325-346, April.
    4. Sargent, Thomas & Wallace, Neil, 1985. "Interest on reserves," Journal of Monetary Economics, Elsevier, vol. 15(3), pages 279-290, May.
    5. Kimbrough, Kent P., 1986. "The optimum quantity of money rule in the theory of public finance," Journal of Monetary Economics, Elsevier, vol. 18(3), pages 277-284, November.
    6. Bruce D. Smith, 1991. "Interest on Reserves and Sunspot Equilibria: Friedman's Proposal Reconsidered," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 58(1), pages 93-105.
    7. Nissan Liviatan & Roni Frish, 2003. "Public Debt in a Long Term Discretionary Model," Bank of Israel Working Papers 2003.07, Bank of Israel.
    8. Poterba, James M & Rotemberg, Julio J, 1990. "Inflation and Taxation with Optimizing Governments," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 22(1), pages 1-18, February.
    9. Mankiw, N. Gregory, 1987. "The optimal collection of seigniorage : Theory and evidence," Journal of Monetary Economics, Elsevier, vol. 20(2), pages 327-341, September.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Liviatan, Nissan & Frish, Roni, 2006. "Interest on reserves and inflation," Journal of Development Economics, Elsevier, vol. 80(1), pages 269-274, June.
    2. Nissan Liviatan & Roni Frish, 2003. "Public Debt in a Long Term Discretionary Model," Bank of Israel Working Papers 2003.07, Bank of Israel.
    3. Song Han & Casey B. Mulligan, 2008. "Inflation and the size of government," Review, Federal Reserve Bank of St. Louis, vol. 90(May), pages 245-267.
    4. Bhattacharya, Joydeep & Haslag, Joseph & Russell, Steven, 2005. "The role of money in two alternative models: When is the Friedman rule optimal, and why?," Journal of Monetary Economics, Elsevier, vol. 52(8), pages 1401-1433, November.
    5. Philip Arestis & Alexander Mihailov, 2011. "Classifying Monetary Economics: Fields And Methods From Past To Future," Journal of Economic Surveys, Wiley Blackwell, vol. 25(4), pages 769-800, September.
    6. Beatrix Paal & Bruce D. Smith, 2013. "The sub-optimality of the Friedman rule and the optimum quantity of money," Annals of Economics and Finance, Society for AEF, vol. 14(2), pages 911-948, November.
    7. Joe Haslag & Joydeep Bhattacharya & Steven Russell, 2003. "Understanding the Roles of Money, or When is the Friedman Rule Optimal, and Why?," Working Papers 0301, Department of Economics, University of Missouri.
    8. Maurice Obstfeld, 1989. "Dynamic Seigniorage Theory: An Exploration," NBER Working Papers 2869, National Bureau of Economic Research, Inc.
    9. Alexandre Cunha, 2008. "The optimality of the Friedman rule when some distorting taxes are exogenous," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 35(2), pages 267-291, May.
    10. Pedro Teles, 2003. "The optimal price of money," Economic Perspectives, Federal Reserve Bank of Chicago, vol. 27(Q II), pages 29-39.
    11. Amano, Robert A., 1998. "On the Optimal Seigniorage Hypothesis," Journal of Macroeconomics, Elsevier, vol. 20(2), pages 295-308, April.
    12. Evans, J. Lynne & Amey, Michael C., 1996. "Seigniorage and tax smoothing: Testing the extended tax-smoothing model," Journal of Macroeconomics, Elsevier, vol. 18(1), pages 111-125.
    13. Eisei Ohtaki, 2016. "Optimality of the Friedman rule under ambiguity," Working Papers e103, Tokyo Center for Economic Research.
    14. Bernardino Adão & André C. Silva, 2021. "Government financing, inflation, and the financial sector," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 71(4), pages 1357-1396, June.
    15. Marco Lossani & Piergiovanna Natale & Patrizio Tirelli, 2001. "Fiscal Policy and Inflation Targets: Does Credibility Matter?," Economia politica, Società editrice il Mulino, issue 3, pages 371-392.
    16. Berument, Hakan, 1998. "Central Bank Independence and Financing Government Spending," Journal of Macroeconomics, Elsevier, vol. 20(1), pages 133-151, January.
    17. Chari, V.V. & Kehoe, Patrick J., 1999. "Optimal fiscal and monetary policy," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 26, pages 1671-1745, Elsevier.
    18. Patrick Honohan, 2003. "Taxation of Financial Intermediation : Theory and Practice for Emerging Economines," World Bank Publications - Books, The World Bank Group, number 15122.
    19. Tahsin SAADI SEDIK, 2003. "Optimal Seigniorage in Developing Countries: An Empirical Investigation," Working Papers 200307, CERDI.
    20. Edwards, Sebastian & Tabellini, Guido, 1991. "The political economy of fiscal policy and inflation in developing countries : an empirical analysis," Policy Research Working Paper Series 703, The World Bank.

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:boi:wpaper:2005.03. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Yossi Yakhin (email available below). General contact details of provider: https://edirc.repec.org/data/boigvil.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.