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Confidence Cycles and Liquidity Hoarding

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  • Volha Audzei

Abstract

Market confidence has proved to be an important factor during past crises. However, many existing general equilibrium models do not account for agents' expectations, market volatility, or overly pessimistic investor forecasts. In this paper, we incorporate a model of the interbank market into a DSGE model, with the interbank market rate and the volume of lending depending on market confidence and the perception of counterparty risk. In our model, a credit crunch occurs if the perception of counterparty risk increases. Our results suggest that changes in market confidence can generate credit crunches and contribute to the depth of recessions. We then conduct an exercise to mimic some central bank policies: targeted and untargeted liquidity provision, and reduction of the policy rate. Our results indicate that policy actions have a limited effect on the supply of credit if they fail to influence agents' expectations. Interestingly, a policy of a low policy rate worsens recessions due to its negative impact on banks' revenues. Liquidity provision stimulates credit slightly, but its efficiency is undermined by liquidity hoarding.

Suggested Citation

  • Volha Audzei, 2016. "Confidence Cycles and Liquidity Hoarding," Working Papers 2016/07, Czech National Bank.
    • Handle: RePEc:cnb:wpaper:2016/07
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    References listed on IDEAS

    as
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    1. Confidence Cycles and Liquidity Hoarding
      by Christian Zimmermann in NEP-DGE blog on 2016-11-16 21:00:22

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    More about this item

    Keywords

    DSGE; expectations; financial intermediation; liquidity provision;
    All these keywords.

    JEL classification:

    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • G01 - Financial Economics - - General - - - Financial Crises
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation

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