A simple general equilibrium model of large excess reserves

Abstract

In a general equilibrium macroeconomic model with a banking system that can hold large excess reserves and is subject to (possibly binding) capital constraints, I study how the quantity of government-provided monetary assets is related to the price level in steady state. When the central bank does not pay interest on reserves, the price level moves one-for-one with the monetary base. If, instead, the central bank can pay interest on reserves at market rates, the price level can decouple from the quantity of monetary assets in the economy: a larger monetary base need not imply a higher price level. However, for large enough levels of reserves, the capital constraint binds and the tight link between money and prices reemerges.