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Interest on Reserves and Forward Guidance in a Deterministic Two Period Model
Abstract
The Fed significantly changed the way that it conducts monetary policy in October, 2008. Before this time, the Fed conducted monetary policy when the reserve market had a scarcity of reserves. As a result, open market operations were an effective tool for influencing
market interest rates. The Fed began paying interest on bank reserves as the FOMC implemented its large-scale asset programs. The interest on reserve tool replaced open market operations as the main monetary policy tool. The purpose of this paper is to build a two sector equilibrium model in order to compare the two tools. The analysis shows that the two tools have the same effect. Thus, the interest on reserve tool is a good substitute tool for open market operations.
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