Liquidity Risk and Monetary Policy
AbstractThis paper provides a framework to analyse emergency liquidity assistance of central banks on financial markets in response to aggregate and idiosyncratic liquidity shocks. The model combines the microeconomic view of liquidity as the ability to sell assets quickly and at low costs and the macroeconomic view of liquidity as a medium of exchange that influences the aggregate price level of goods. The central bank faces a trade-off between limiting the negative output effects of dramatic asset price declines and more inflation. Furthermore, the anticipation of central bank intervention causes a moral hazard effect with investors. This gives rise to the possibility of an optimal monetary policy under commitment.
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Bibliographic InfoPaper provided by University of Munich, Department of Economics in its series Discussion Papers in Economics with number 2012.
Date of creation: Aug 2007
Date of revision:
Liquidity shocks; Financial crises; Liquidity provision principle; Greenspan put; Optimal monetary policy intervention;
Find related papers by JEL classification:
- E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
- E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
- G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2007-08-27 (All new papers)
- NEP-CBA-2007-08-27 (Central Banking)
- NEP-MAC-2007-08-27 (Macroeconomics)
- NEP-MON-2007-08-27 (Monetary Economics)
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- Nikolaou, Kleopatra, 2009. "Liquidity (risk) concepts: definitions and interactions," Working Paper Series 1008, European Central Bank.
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