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“Optimal Negative Interest on Bank Reserves: the Maturity-Transformation Channel of Monetary Policy Transmission”
This paper studies the role of the interest rate on bank reserves in monetary policy. For this purpose, I consider a model with a banking sector, where the transmission of monetary policy to the interbank market is explicitly modelled via open market operations and the interest on reserves. First, I show that the lower bound applies to the interbank rate (i.e., the conventional monetary policy instrument) but not to the interest on reserves. Nonetheless, if deposits and other assets are perfect substitutes, changes in the interest on reserves per se have no macroeconomic effect. I model banks according to the classical maturity-transformation framework of Diamond and Dybvig (1983). Banks transform the available assets into deposits, which better suit the consumers’ liquidity needs, and by doing so they promote consumers’ saving behaviour. I show that maturity transformation makes deposits and other assets imperfect substitutes. This creates the maturity-transformation channel of monetary policy, whereby a reduction in the interest on reserves, which leaves the interbank rate unchanged, increases aggregate demand. However, there is a downside to boosting demand through this channel: consumers also respond by moving part of their wealth away from deposits into direct asset holdings. Such disintermediation is detrimental to welfare in this setting, because deposits provide valuable liquidity-risk insurance. An interesting policy trade-off emerges between preserving a fully functional banking system and stimulating demand. The paper’s main finding is that, when the interbank rate is constrained by its lower bound, optimal monetary policy prescribes an interest on reserves strictly below the lower bound on the interbank rate.