Is Reserve-ratio Arithmetic More Pleasant?

Date
2003-08-01
Authors
Bhattacharya, Joydeep
Haslag, Joseph
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Economics
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Abstract

Does it matter in a revenue-neutral setting if the government changes the inflation tax base or the inflation tax rate? We answer this question within the context of an overlapping-generations model in which government bonds, capital and cash reserves coexist. We consider experiments that parallel those studied in Sargent and Wallace's ‘unpleasant monetarist arithmetic’; the government uses seigniorage to service its debt, choosing between changing either the money growth rate (the inflation tax rate) or the reserve-requirement ratio (the inflation tax base). In the former case we obtain standard unpleasant arithmetic; in the long run a permanent open market sale results in higher money growth, and higher long-run inflation. Somewhat surprisingly, it turns out that, for a given money growth rate, lower reserve requirements fund the government's interest expense. Associated with the lower reserve requirements is lower long-run inflation and higher welfare, compared with the money-growth case. The broad message is that reserve-ratio arithmetic can be pleasant even when money-growth arithmetic is not.

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This is the pre-peer reviewed version of the following article: Bhattacharya, Joydeep, and Joseph H. Haslag. "Is Reserve‐ratio Arithmetic More Pleasant?." Economica 70, no. 279 (2003): 471-491, which has been published in final form at doi:10.1111/1468-0335.01160. This article may be used for non-commercial purposes in accordance with Wiley Terms and Conditions for Use of Self-Archived Versions.

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