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Collateral Framework: Liquidity Premia and Multiple Equilibria

Author

Listed:
  • Lengwiler, Yvan

    (University of Basel)

  • Orphanides, Athanasios

Abstract

Central banks normally accept debt of their own governments as collateral in liquidity operations without reservations. This gives rise to a valuable liquidity premium that reduces the cost of government finance. The ECB is an interesting exception in this respect. It relies on external assessments of the creditworthiness of its member states, such as credit ratings, to determine eligibility and the haircut it imposes on such debt. We show how such features in a central bank's collateral framework can give rise to cliff effects and multiple equilibria in bond yields and increase the vulnerability of governments to external shocks. This can potentially induce sovereign debt crises and defaults that would not otherwise arise.

Suggested Citation

  • Lengwiler, Yvan & Orphanides, Athanasios, 2021. "Collateral Framework: Liquidity Premia and Multiple Equilibria," Working papers 2021/06, Faculty of Business and Economics - University of Basel.
    • Handle: RePEc:bsl:wpaper:2021/06
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    References listed on IDEAS

    as
    1. Luigi Bocola & Alessandro Dovis, 2019. "Self-Fulfilling Debt Crises: A Quantitative Analysis," American Economic Review, American Economic Association, vol. 109(12), pages 4343-4377, December.
    2. Anil K. Kashyap & Raghuram Rajan & Jeremy C. Stein, 2002. "Banks as Liquidity Providers: An Explanation for the Coexistence of Lending and Deposit‐taking," Journal of Finance, American Finance Association, vol. 57(1), pages 33-73, February.
    Full references (including those not matched with items on IDEAS)

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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Collateral Framework: Liquidity Premia and Multiple Equilibria
      by Christian Zimmermann in NEP-DGE blog on 2021-05-03 16:46:21

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    More about this item

    Keywords

    monetary policy; government finance; yields; liquidity premium; default premium; collateral; cliff effect; multiple equilibria.;
    All these keywords.

    JEL classification:

    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects

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