Speculative runs on interest rate pegs

Marco Bassetto, Christopher Phelan

Research output: Contribution to journalArticlepeer-review

5 Scopus citations

Abstract

We analyze a new class of equilibria that emerges when a central bank conducts monetary policy by setting an interest rate (as an arbitrary function of its available information) and letting the private sector set the quantity traded. These equilibria involve a run on the central bank[U+05F3]s interest target, whereby money grows fast, private agents borrow as much as possible against the central bank, and the shadow interest rate is different from the policy target. We argue that these equilibria represent a particular danger when banks hold large excess reserves, such as is the case following periods of quantitative easing. Our analysis suggests that successfully managing the exit strategy requires additional tools beyond setting interest-rate targets and paying interest on reserves; in particular, freezing excess reserves or fiscal-policy intervention may be needed to fend off adverse expectations.

Original languageEnglish (US)
Pages (from-to)99-114
Number of pages16
JournalJournal of Monetary Economics
Volume73
DOIs
StatePublished - Jul 1 2015

Bibliographical note

Funding Information:
For valuable suggestions, we thank the editor (Marvin Goodfriend), Fernando Alvarez, Gadi Barlevy, Robert Barsky, Mariacristina De Nardi, Timothy S. Fuerst, Robert E. Lucas, Jr., Thomas J. Sargent, and an anonymous referee. Marco Bassetto acknowledges financial support from the ESRC Grant #ES/L500343/1 through the Centre for Macroeconomics. This paper was presented at the November 2014 Carnegie-Rochester-NYU Conference on Public Policy. The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Banks of Chicago or Minneapolis or the Federal Reserve System.

Keywords

  • Inflation
  • Interest rate rule
  • Quantitative easing
  • Run

Fingerprint Dive into the research topics of 'Speculative runs on interest rate pegs'. Together they form a unique fingerprint.

Cite this