Working Paper: NBER ID: w22761
Authors: Robert E. Hall; Ricardo Reis
Abstract: Today, all major central banks pay or collect interest on reserves, and stand ready to use the interest rate as an instrument of monetary policy. We show that by paying an appropriate rate on reserves, the central bank can pin the price level uniquely to a target. The essential idea is to index payments on reserves to the price level and the target price level in a way that creates a contractionary financial force if the price level is above the target and an expansionary force if below. Our payment-on-reserves policy process does not require terminal conditions like Taylor rules, exogenous fiscal surpluses like the fiscal theory of the price level, liquidity preference as in quantity theories, or local approximations as in new Keynesian models. The process accommodates liquidity services from reserves, segmented financial markets where only some institutions can hold reserves, and nominal rigidities. We believe it would be easy to implement.
Keywords: Central Banks; Price Stability; Monetary Policy; Reserves
JEL Codes: E31; E42; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| payment on reserves (G21) | price level (E30) |
| adjustment of payment on reserves according to real interest rate (E43) | price level (E30) |
| payment on reserves (G21) | financial stability (G28) |
| payment on reserves process accommodates liquidity services and nominal rigidities (E50) | price level (E30) |
| payment on reserves process avoids issues of indeterminacy (E49) | robustness of causal mechanisms (C90) |