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The Use of Reserve Requirements in an Optimal Monetary Policy Framework

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  • Hernando Vargas Herrera
  • Pamela Cardozo

Abstract

We analyse three models to determine the conditions under which reserve requirements are used as a part of an optimal monetary policy framework in an inflation targeting regime. In all cases the Central Bank (CB) minimizes an objective function that depends on deviations of inflation from its target, the output gap and deviations of reserve requirements from its optimal long term level. In a closed economy model we find that optimal monetary policy implies setting reserve requirements at their long term level, while adjusting the policy interest rate to face macroeconomic shocks. Reserve requirements are included in an optimal monetary policy response in an open economy model with the same CB objective function and in a closed economy model in which the CB objective function includes financial stability. The relevance, magnitude and direction of the movements of reserve requirements depend on the parameters of the economy and the shocks that affect it.

Suggested Citation

  • Hernando Vargas Herrera & Pamela Cardozo, 2012. "The Use of Reserve Requirements in an Optimal Monetary Policy Framework," Borradores de Economia 9824, Banco de la Republica.
    • Handle: RePEc:col:000094:009824
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    References listed on IDEAS

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    1. Christian Glocker & Pascal Towbin, 2012. "The Macroeconomic Effects of Reserve Requirements," WIFO Working Papers 420, WIFO.
    2. Christian Glocker & Pascal Towbin, 2012. "Reserve Requirements for Price and Financial Stability: When Are They Effective?," International Journal of Central Banking, International Journal of Central Banking, vol. 8(1), pages 65-114, March.
    3. Disyatat, Piti, 2010. "Inflation targeting, asset prices, and financial imbalances: Contextualizing the debate," Journal of Financial Stability, Elsevier, vol. 6(3), pages 145-155, September.
    4. Rocío Betancourt & Hernando Vargas, 2009. "Encajes bancarios y tasas de interés," Revista ESPE - Ensayos Sobre Política Económica, Banco de la República, vol. 27(59), pages 158-186, June.
    5. Hernando Vargas H, 2011. "Monetary policy and the exchange rate in Colombia," BIS Papers chapters, in: Bank for International Settlements (ed.), Capital flows, commodity price movements and foreign exchange intervention, volume 57, pages 129-153, Bank for International Settlements.
    6. Hernando Vargas Herrera & Yanneth R Betancourt & Carlos Varela & Norberto Rodriguez, 2011. "Effects of reserve requirements in an inflation targeting regime: the case of Colombia," BIS Papers chapters, in: Bank for International Settlements (ed.), The global crisis and financial intermediation in emerging market economies, volume 54, pages 133-169, Bank for International Settlements.
    7. Bernanke, Ben S & Blinder, Alan S, 1988. "Credit, Money, and Aggregate Demand," American Economic Review, American Economic Association, vol. 78(2), pages 435-439, May.
    8. Reinhart, Carmen M & Reinhart, Vincent R, 1999. "On the Use of Reserve Requirements in Dealing with Capital Flow Problems," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 4(1), pages 27-54, January.
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    Cited by:

    1. Urrutia, Miguel & Hofstetter, Marc & Hamann, Franz, 2014. "Inflation Targeting in Colombia, 2002-2012," IDB Publications (Working Papers) 6394, Inter-American Development Bank.
    2. Marco Vega & Adrian Armas & Paul Castillo, 2014. "Inflation Targeting and Quantitative Tightening: Effects of Reserve Requirements in Peru," ECONOMIA JOURNAL OF THE LATIN AMERICAN AND CARIBBEAN ECONOMIC ASSOCIATION, ECONOMIA JOURNAL OF THE LATIN AMERICAN AND CARIBBEAN ECONOMIC ASSOCIATION, vol. 0(Fall 2014), pages 133-175, June.
    3. Hoffmann, Andreas & Löffler, Axel, 2014. "Low interest rate policy and the use of reserve requirements in emerging markets," The Quarterly Review of Economics and Finance, Elsevier, vol. 54(3), pages 307-314.
    4. Ryota Nakatani, 2016. "Twin Banking and Currency Crises and Monetary Policy," Open Economies Review, Springer, vol. 27(4), pages 747-767, September.
    5. Hoffmann, Andreas & Loeffler, Axel, 2013. "Low interest rate policy and the use of reserve requirements in emerging markets," Working Papers 120, University of Leipzig, Faculty of Economics and Management Science.

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    More about this item

    Keywords

    Reserve Requirements; Inflation Targeting; Monetary Policy.;
    All these keywords.

    JEL classification:

    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • 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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