A general equilibrium analysis of short-term interest rate policies and the role of reserve requirements

Using a general equilibrium model, this paper analyzes the transmission of short-term interest rate policies aimed at exchange rate stabilization or money stock targeting, and addresses the usefulness of reserve requirements imposed to sustain these policies. It is concluded that the financial effects of these instruments are mostly ambiguous, and depend crucially on the financial structure. Changes in net foreign assets of banks are found to convey little information on tension in the exchange market. Finally, a market-based remuneration of required reserves may impair or increase the effectiveness of monetary policy, depending on the choice of policy target.