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“Optimal Negative Interest on Bank Reserves: the Maturity-Transformation Channel of Monetary Policy Transmission”
A negative interest rate on reserves is effectively a tax on the banking system. The rationale for adopting such policy in the context of a classic liquidity trap is its expansionary effect, via the reduction in the incentive to save. However, critics argue that the distortion in the banking system may well have adverse effects which outweigh the welfare gains from economic stimulus. This paper contributes to the debate by modelling the banking sector in accordance with the maturity-transformation framework of Diamond and Dybvig (1983). I show that, on the one hand, negative interest on reserves leads to financial disintermediation, which reduces the extent of maturity transformation below the first-best level; while, on the other hand, it is expansionary, as consumers save less overall. The paper's main finding is that, while in normal times taxing banks is inefficient, optimal monetary policy in the liquidity trap prescribes a strictly negative interest on reserves.