Interest on Reserves as a Main Monetary Policy Tool

This paper examines the potential role of the interest on reserves as a main monetary policy tool, in a model of financial intermediation with financial and nominal frictions calibrated to US data (1985-2018). The interest on reserves is shown to affect financial spreads and real economic activity, through its effect on the banking system's reserves (balance sheet channel) and the price of safe liquid assets (intertemporal Euler equation channel). It is shown to provide, (i) determinacy when the interest rate is pegged, through the intertemporal Euler equation channel, independently of the size of reserves, bank capital restrictions, or fiscal policy; (ii) similar welfare improvements to an optimal Taylor rule; (iii) an alternative main monetary policy tool for driving the economy out of recessions when the conventional interest rate is trapped at the zero-lower-bound