Credit Risk, Excess Reserves and Monetary Policy: The Deposits Channel

This paper examines the role of precautionary liquidity (reserves) and the interest on reserves as two potential determinants of the deposits channel that can help explain the role of monetary policy, particularly at the near zero-bound. Through the deposits channel and balance sheet channel either of these determinants can explain a number of effects including, (i) zero-bound optimal policy rates, (ii) a negative deposit rate spread, but also (iii) determinacy at the lower-zero bound. Similarly, through its effect on the deposits channel and balance sheet channel the interest on reserves can act as the main tool of monetary policy, that is shown to provide higher welfare gains in relation to a simple Taylor rule. This result is shown to hold at the zero-bound and it is independent of precautionary liquidity, or the fiscal theory of the price level.