Working Paper: CEPR ID: DP18103
Authors: Paul De Grauwe; Yuemei Ji
Abstract: The massive programs of government bond buying have led to a fundamental change in the operating procedure of the major central banks. The latter now operate in a regime of abundance of bank reserves. This makes it impossible to raise the money market rate except by increasing the rate of remuneration of bank reserves. This, in turn, leads to a massive transfer of the central banks’ profits to commercial banks that will become unsustainable. We argue that the remuneration of bank reserves is not inevitable and that there is an alternative to the current central banks’ operating procedure that avoids making profit transfers to private agents. We propose to use minimum reserve requirements as a policy tool to achieve this objective. Our favoured proposal is a two-tier system of reserve requirements that would only remunerate the reserves in excess of the minimum required. This would drastically reduce the giveaways to banks and allow the central banks to maintain their current operating procedures.
Keywords: monetary policy; central bank; reserves; inflation
JEL Codes: E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| current remuneration of bank reserves (E52) | effective monetary policy (E52) |
| increasing the remuneration rate of bank reserves (E52) | transfer of profits to commercial banks (G21) |
| transfer of profits to commercial banks (G21) | distortion of monetary policy (E52) |
| implementing minimum reserve requirements (E52) | eliminate need for remuneration (J33) |
| eliminate need for remuneration (J33) | stabilize monetary system (E42) |
| current regime of abundant reserves (P18) | inability to raise interest rates effectively (E43) |
| return to a regime of scarce reserves (E63) | better monetary control (E64) |