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Every week, the Economics Group of King's Business School organises research seminars in economics. Bi-weekly the seminars are organised together with the Department of Political Economy and International Development. These seminars will take place on Wednesdays from 12.00 - 1.30 pm in Bush House, room (South) 3.01.
The paper I will present examines the role of, (a) the precautionary demand for liquidity and (b) the interest on reserves, as two potential determinants of the deposits channel that can help explain the role of monetary policy, particularly at the lower zero-bound. (a) I show that at high levels of precautionary liquidity hoarding the optimal policy response of a Taylor rule is to place a zero weight on inflation. This result is explained by the effect that the demand for liquidity has on the deposit rate which determines the intertemporal choices of households. A higher demand for precautionary liquidity raises the deposit rate and controls the Euler equation, thus substituting for the effects of the policy rate (i.e. a Taylor rule). (b) Similarly, through its effect on the deposits channel the interest on reserves is shown to act as a single tool of monetary policy, that is capable of providing higher welfare gains in relation to a simple Taylor rule. This result is shown to hold at the zero-bound and it is independent of the precautionary demand for liquidity, or properties of the fiscal theory of the price level.
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