Money and Banking in a New Keynesian Model
This paper studies a New Keynesian model with a two-layer payment system, in which payments among banks use reserves while payments among households use inside money provided by banks. The main point of the paper is that if the central bank's policy rate is the rate on an asset with a convenience yield, then the usual "irrelevance of money" proposition no longer holds. The response to monetary policy shocks as well as the determinacy properties of the economy change. The simplest version of the model derives the convenience yields from (separable) money in the utility function within a setup in which all agents have reserve accounts at the central bank which directly controls the quantity and interest on reserves. We then show that a richer model in which only banks have reserve accounts, and banks choose the supply and interest rate on inside money has a similar structure and additional observable implications.