Illiquid Banks, Financial Stability, and Interest Rate Policy
AbstractBanks finance illiquid assets with demandable deposits, which discipline bankers but expose them to damaging runs. Authorities may not want to stand by and watch banks collapse. However, unconstrained direct bailouts undermine the disciplinary role of deposits. Moreover, competition forces banks to promise depositors more, increasing intervention and making the system worse off. By contrast, constrained central bank intervention to lower rates maintains private discipline, while offsetting contractual rigidity. It may still lead banks to make excessive liquidity promises. Anticipating this, central banks should raise rates in normal times to offset distortions from reducing rates in adverse times.
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Bibliographic InfoArticle provided by University of Chicago Press in its journal Journal of Political Economy.
Volume (Year): 120 (2012)
Issue (Month): 3 ()
Pages: 552 - 591
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Web page: http://www.journals.uchicago.edu/JPE/
Other versions of this item:
- Douglas W. Diamond & Raghuram Rajan, 2011. "Illiquid Banks, Financial Stability, and Interest Rate Policy," NBER Working Papers 16994, National Bureau of Economic Research, Inc.
- E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
- E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
- G2 - Financial Economics - - Financial Institutions and Services
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Tobias Adrian & Hyun Song Shin, 2008. "Financial intermediaries, financial stability, and monetary policy," Staff Reports 346, Federal Reserve Bank of New York.
- Xavier Freixas & Antoine Martin & David Skeie, 2010.
"Bank liquidity, interbank markets and monetary policy,"
Economics Working Papers
1202, Department of Economics and Business, Universitat Pompeu Fabra.
- Xavier Freixas & Antoine Martin & David Skeie, 2011. "Bank Liquidity, Interbank Markets, and Monetary Policy," Review of Financial Studies, Society for Financial Studies, vol. 24(8), pages 2656-2692.
- Xavier Freixas & Antoine Martin & David Skeie, 2010. "Bank Liquidity, Interbank Markets and Monetary Policy," Working Papers 429, Barcelona Graduate School of Economics.
- Freixas, X. & Martin, A. & Skeie, D., 2010. "Bank Liquidity, Interbank Markets, and Monetary Policy," Discussion Paper 2010-35S, Tilburg University, Center for Economic Research.
- Xavier Freixas & Antoine Martin & David Skeie, 2009. "Bank liquidity, interbank markets, and monetary policy," Staff Reports 371, Federal Reserve Bank of New York.
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