The federal funds market, excess reserves, and unconventional monetary policy
AbstractFollowing the bankruptcy of Lehman Brothers, interbank borrowing and lending dropped, whereas reserve holdings of depository institutions skyrocketed, as the Fed injected liquidity into the U.S. banking sector. This paper introduces bank liquidity risk and limited market participation into a real business cycle model with ex ante identical financial intermediaries and shows, in an analytically tractable way, how interbank trade and excess reserves emerge in general equilibrium. Investigating the role of the federal funds market and unconventional monetary policy for the propagation of aggregate real and financial shocks, I find that federal funds market participation is irrelevant in response to standard supply and demand shocks, whereas it matters for “uncertainty shocks”, i.e. mean-preserving spreads in the cross-section of liquidity risk. Liquidity injections by the central bank can absorb the effects of financial shocks on the real economy, although excess reserves might increase and federal funds might be crowded out, as a side effect.
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Bibliographic InfoPaper provided by Department of Economics, Johannes Kepler University Linz, Austria in its series Economics working papers with number 2013-12.
Length: 46 pages
Date of creation: Sep 2013
Date of revision:
Excess reserves; Federal funds market; Financial frictions; Liquidity risk; Unconventional monetary policy;
Find related papers by JEL classification:
- C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
- E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
- E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-10-05 (All new papers)
- NEP-CBA-2013-10-05 (Central Banking)
- NEP-DGE-2013-10-05 (Dynamic General Equilibrium)
- NEP-MAC-2013-10-05 (Macroeconomics)
- NEP-MON-2013-10-05 (Monetary Economics)
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