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The great escape? A quantitative evaluation of the Fed’s liquidity facilities

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Author Info

  • Marco Del Negro
  • Gauti Eggertsson
  • Andrea Ferrero
  • Nobuhiro Kiyotaki

Abstract

We introduce liquidity frictions into an otherwise standard DSGE model with nominal and real rigidities, explicitly incorporating the zero bound on the short-term nominal interest rate. Within this framework, we ask: Can a shock to the liquidity of private paper lead to a collapse in short-term nominal interest rates and a recession like the one associated with the 2008 U.S. financial crisis? Once the nominal interest rate reaches the zero bound, what are the effects of interventions in which the government exchanges liquid government assets for illiquid private paper? We find that the effects of the liquidity shock can be large, and we show some numerical examples in which the liquidity facilities prevented a repeat of the Great Depression in 2008-09.

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Bibliographic Info

Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 520.

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Date of creation: 2011
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Handle: RePEc:fip:fednsr:520

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Keywords: Federal Reserve System ; Interest rates ; Liquidity (Economics) ; Private equity;

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  1. Juan-Carlos Cordoba & Marla Ripoll, 2004. "Credit Cycles Redux," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 45(4), pages 1011-1046, November.
  2. Dimitri Vayanos & Jean-Luc Vila, 2009. "A Preferred-Habitat Model of the Term Structure of Interest Rates," NBER Working Papers 15487, National Bureau of Economic Research, Inc.
  3. Tobias Adrian & Christopher R. Burke & James J. McAndrews, 2009. "The Federal Reserve's Primary Dealer Credit Facility," Current Issues in Economics and Finance, Federal Reserve Bank of New York, vol. 15(Aug).
  4. Francois Gourio & Anil K Kashyap, 2007. "Investment Spikes: New Facts And A General Equilibrium Exploration," Boston University - Department of Economics - Working Papers Series WP2007-006, Boston University - Department of Economics.
  5. Alejandro Justiniano & Giorgio E. Primiceri & Andrea Tambalotti, 2008. "Investment shocks and business cycles," Staff Reports 322, Federal Reserve Bank of New York.
  6. Vasco Curdia & Andrea Ferrero & Han Chen, 2012. "The Macroeconomic Effects of Large-Scale Asset Purchase Programs," 2012 Meeting Papers 372, Society for Economic Dynamics.
  7. Tobias Adrian & Emanuel Moench & Hyun Song Shin, 2010. "Macro risk premium and intermediary balance sheet quantities," Staff Reports 428, Federal Reserve Bank of New York.
  8. Emi Nakamura & Jón Steinsson, 2008. "Five Facts about Prices: A Reevaluation of Menu Cost Models," The Quarterly Journal of Economics, MIT Press, vol. 123(4), pages 1415-1464, November.
  9. Zheng Liu & Pengfei Wang & Tao Zha, 2009. "Do Credit Constraints Amplify Macroeconomic Fluctuations?," Emory Economics 0910, Department of Economics, Emory University (Atlanta).
  10. Michael J. Fleming & Warren B. Hrung & Frank M. Keane, 2009. "The Term Securities Lending Facility: origin, design, and effects," Current Issues in Economics and Finance, Federal Reserve Bank of New York, vol. 15(Feb).
  11. Goodfriend, Marvin & McCallum, Bennett T., 2007. "Banking and interest rates in monetary policy analysis: A quantitative exploration," Journal of Monetary Economics, Elsevier, vol. 54(5), pages 1480-1507, July.
  12. Ajello, Andrea, 2010. "Financial intermediation, investment dynamics and business cycle fluctuations," MPRA Paper 32447, University Library of Munich, Germany, revised Mar 2011.
  13. Gauti B. Eggertsson, 2008. "Great Expectations and the End of the Depression," American Economic Review, American Economic Association, vol. 98(4), pages 1476-1516, September.
  14. Vasco Cúrdia & Michael Woodford, 2008. "Credit frictions and optimal monetary policy," Working Paper Research 146, National Bank of Belgium.
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