A Model of Post-2008 Monetary Policy

We introduce banks and bank reserves into the basic New Keynesian model and allow the central bank to set both the interest rate on reserves (IOR rate) and the nominal stock of reserves. Our model can account, in qualitative terms, for three key features of U.S. inflation during the recent zero-lower-bound (ZLB) episodes: no significant deflation, little inflation volatility, and no significant inflation following quantitative-easing policies. Crucial to this result is our assumption that demand for bank reserves got close to satiation, but did not reach full satiation. We introduce liquid government bonds into the model to reconcile our nonsatiation assumption with the fact that Treasury-bill rates were often below the IOR rate during the ZLB episodes. Looking ahead, we explore the implications of our model for the normalization of monetary policy and its operational framework (floor system).