A Post-Keynesian Approach
New Directions in Modern Economics series
Edited by Claude Gnos and Louis-Philippe Rochon
Chapter 6: Monetary Policy Without Reserve Requirements: Central Bank Money as Means of Final Payment on the Interbank Market
Louis-Philippe Rochon and Sergio Rossi* INTRODUCTION One of the most recent, and perhaps most important, innovations in central banking has been the elimination of reserve requirements. Today, a number of countries (in particular Australia, Canada, Mexico, New Zealand, Sweden and the United Kingdom) have eliminated them completely, while in several other countries they have been reduced considerably, such as in the United States. This innovation has raised many questions, one of the most crucial among them being whether central banks are still able to set interest rates exogenously. Indeed, Palley (2003, pp. 67–8) states categorically that ‘[o]ne problem posed by innovation and banking disintermediation is that the conduct of monetary policy may have become more difficult owing to reduced bank demand for liabilities of the central bank’. A number of post-Keynesian economists have examined closely modern central banking practices in light of recent innovations. In particular, Chartalists, such as Mosler (1997–98) and Wray (1998), provided detailed accounts of central banking in connection to the state. In addition, horizontalists, such as Lavoie (2005a, 2005b), have gone a step further, by specifically exploring central banking in a zero-reserve environment. While there are a number of similarities between these two approaches, such as the exogeneity of short-term nominal rates of interest, there remain some unexplored differences. In particular, while both approaches agree that ‘the payment system, rather than reserve requirements, is the proper starting point for analysis of the [central bank]’s daily tactics’ (Fullwiler, 2003, p. 853), they disagree...
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