The Expected Target Rate and the Short-term Interest Rate

It is important to understand how the central bank manages the monetary operation when studying the effect of monetary policy. But the researchers of economics and the officials of the Bank of Japan do not agree on how to manage the monetary operation, especially on whether or not the monetary authority should regulate the high-powered money, that is, the cash and the reserve. The former insists that the central bank should regulate the high-powered money in order to control the total money supply. The latter insists that the central bank should not regulate the high-powered money and ought to make use of the lagged reserve requirement system to control the short-term interest rate by adjusting the speed at which the private bank accumulates the required reserve. The aim of this paper is to examine whether the central bank can control the short-term interest rate as the officials of BOJ insist. To this aim, the model is constructed as the game played between the central bank and the private bank. This model is an extended version based on Mori(1998). The assumptions of the model are the following. The private bank has to accumulate the required reserve during three periods. The private bank decides how much reserve she holds at each period, so as to minimize the cost of holding it. The central bank has the target interest rate, the selected value of which the private bank does not know, and supplies the reserve at each period, the sum of which must be equal to the required one. But at each period except the last one, the central bank can decide how much reserve she supplies in order to realize the target interest rate. In the analysis of this paper, attention is paid to the way the private bank expects the value of the target rate of the central bank. So three cases are examined in terms of how the private bank expects it. The first is that the private bank expects the value of the target rate using all available information such as the supply of reserve and the interest rate of the last period. The second case is that she does not use such information. The last is in the middle of these cases, that is, she expects the target rate value using only the current supply of reserve. The results are the following. The central bank can control the short-term interest rate by adjusting the speed at which the private bank accumulates the required reserve whenever the latter expects the target rate using at least the supply of reserve among the available information including the interest rate of the last period