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Is Reserve-ratio Arithmetic More Pleasant?

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  • Bhattacharya, Joydeep
  • Haslag, Joseph H.

Abstract

Does it matter in a revenue-neutral setting if the government changes the inflation tax base or the inflation tax rate? We answer this question within the context of an overlapping-generations model in which government bonds, capital and cash reserves coexist. We consider experiments that parallel those studied in Sargent and Wallace's ‘unpleasant monetarist arithmetic’; the government uses seigniorage to service its debt, choosing between changing either the money growth rate (the inflation tax rate) or the reserve-requirement ratio (the inflation tax base). In the former case we obtain standard unpleasant arithmetic; in the long run a permanent open market sale results in higher money growth, and higher long-run inflation. Somewhat surprisingly, it turns out that, for a given money growth rate, lower reserve requirements fund the government's interest expense. Associated with the lower reserve requirements is lower long-run inflation and higher welfare, compared with the money-growth case. The broad message is that reserve-ratio arithmetic can be pleasant even when money-growth arithmetic is not.

Suggested Citation

  • Bhattacharya, Joydeep & Haslag, Joseph H., 2003. "Is Reserve-ratio Arithmetic More Pleasant?," ISU General Staff Papers 200308010700001822, Iowa State University, Department of Economics.
    • Handle: RePEc:isu:genstf:200308010700001822
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    1. Joydeep Bhattacharya & Noritaka Kudoh, 2002. "Tight money policies and inflation revisited," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 35(2), pages 185-217, May.
    2. Woodford, Michael, 1994. "Monetary Policy and Price Level Determinacy in a Cash-in-Advance Economy," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 4(3), pages 345-380.
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    7. Bruce Smith & J. Bhattacharya & Mark Guzman, 1998. "Some Even More Unpleasant Monetarist Arithmetic," Canadian Journal of Economics, Canadian Economics Association, vol. 31(3), pages 596-623, August.
    8. Click, Reid W, 1998. "Seigniorage in a Cross-Section of Countries," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 30(2), pages 154-171, May.
    9. Scott Freeman & Joseph H. Haslag, 1996. "On the optimality of interest-bearing reserves in economies of overlapping generations (*)," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 7(3), pages 557-565.
    10. Barnett, Richard C., 2005. "Coordinating macroeconomic policy in a simple AK growth model," Journal of Macroeconomics, Elsevier, vol. 27(4), pages 621-647, December.
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    1. Barnett, Richard C., 2005. "Coordinating macroeconomic policy in a simple AK growth model," Journal of Macroeconomics, Elsevier, vol. 27(4), pages 621-647, December.
    2. Carrera, César, 2012. "Políticas de Encajes y Modelos Económicos," Working Papers 2012-006, Banco Central de Reserva del Perú.

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