May 07, 2020

The government through its policy actions can speed or slowdown the adjustment process. For example, one can argue that expanding the balance sheet during the crisis prevented a larger bout of deflation. But then again, the excess reserve had an undesired effect. As the balance sheet expanded, so did the banking system excess reserves, the spread between the high yield, and the interest rate paid on deposits widened. The corporate high yield rose while the interest rate paid on the deposits fell. Our framework suggests that the excess reserves increase is sufficiently large, it could very well result in negative interest rates.

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