Liquidity Shortages and Monetary Policy
AbstractThe paper models the interaction between risk taking in the financial sector and central bank policy. It shows that in the absence of central bank intervention, the incentive of financial intermediaries to free ride on liquidity in good states may result in excessively low liquidity in bad states. In the prevailing mixed-strategy equilibrium, depositors are worse off than if banks would coordinate on more liquid investment. It is shown that public provision of liquidity improves the allocation, even though it encourages more risk taking (less liquid investment) by private banks.
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Bibliographic InfoPaper provided by University of Munich, Department of Economics in its series Discussion Papers in Economics with number 2008.
Date of creation: Jul 2007
Date of revision:
Liquidity Provision; Monetary Policy; Bank Runs;
Other versions of this item:
- E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2007-08-08 (All new papers)
- NEP-BAN-2007-08-08 (Banking)
- NEP-CBA-2007-08-08 (Central Banking)
- NEP-MAC-2007-08-08 (Macroeconomics)
- NEP-MON-2007-08-08 (Monetary Economics)
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- Jin Cao & Gerhard Illing, 2009.
"Endogenous Systemic Liquidity Risk,"
CESifo Working Paper Series
2627, CESifo Group Munich.
- Nikolaou, Kleopatra, 2009. "Liquidity (risk) concepts: definitions and interactions," Working Paper Series 1008, European Central Bank.
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