Excess bank reserves and monetary policy with a lower-bound lending rate

This paper posits that a threshold loan rate, identified by a flat long-term demand curve for excess reserves, is a minimum mark-up lending rate. At the threshold rate the risk adjusted marginal revenue is equal to the marginal cost of extending loans. An excess reserves-loan (RL) equation, which embeds the mark-up rate, is proposed to link excess reserves and aggregate output. The RL equation is combined with an IS equation, emphasizing the loan rate rather than the government bond rate, to obtain equilibrium output. The output gap is then introduced as a forcing process in a dynamic equation that allows for the analysis of the impact of excess reserves on inflation at the loan interest threshold. The model allows for performing several simulation exercises of the effect of monetary policy at the threshold loan interest rate.