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Excess Liquidity, Bank Pricing Rules, and Monetary Policy

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  • Pierre-Richard Agénor
  • Karim El Aynaoui

Abstract

This paper analyzes the implications of excess bank liquidity for the effectiveness of monetary policy in a simple model with credit market imperfections. Lending rates are set as a premium over the cost of borrowing from the central bank, with the premium itself depending on firms’ net worth. The demand for excess reserves is determined by precautionary factors and opportunity cost variables. The basic framework is used to examine the impact of a change in the refinance rate and the required reserve ratio. The analysis is then extended to account for the impact of excess liquidity on bank pricing rules and macroeconomic equilibrium. Symmetric and asymmetric rules are shown to provide new explanations of the “price puzzle” or “stagflationary” effect associated with contractionary monetary policy.

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Paper provided by Economics, The Univeristy of Manchester in its series Centre for Growth and Business Cycle Research Discussion Paper Series with number 105.

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Length: 39 pages
Date of creation: 2008
Date of revision:
Handle: RePEc:man:cgbcrp:105

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Citations

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Cited by:
  1. Chong, Beng Soon, 2010. "Interest rate deregulation: Monetary policy efficacy and rate rigidity," Journal of Banking & Finance, Elsevier, vol. 34(6), pages 1299-1307, June.
  2. Pierre-Richard Agénor & Luiz A. Pereira da Silva, 2011. "Macroprudential Regulation and the Monetary Transmission Mechanism," Working Papers Series 254, Central Bank of Brazil, Research Department.
  3. Pierre-Richard Agénor & Luiz A. Pereira da Silva, 2013. "Inflation Targeting and Financial Stability: A Perspective from the Developing World," Working Papers Series 324, Central Bank of Brazil, Research Department.
  4. Deraniyagala, Sonali & Kaluwa, Ben, 2011. "Macroeconomic policy for employment creation: The case of Malawi," MPRA Paper 52715, University Library of Munich, Germany.
  5. Ila Patnaik & Ajay Shah & Rudrani Bhattacharya, 2011. "Monetary Policy Transmission in an Emerging Market Setting," IMF Working Papers 11/5, International Monetary Fund.
  6. Primus, Keyra, 2013. "Excess Reserves, Monetary Policy and Financial Volatility," MPRA Paper 51670, University Library of Munich, Germany.
  7. William Barnett & Logan Kelly & John Keating, 2010. "Rethinking the Liquidity Puzzle: Application of a New Measure of the Economic Money Stock," WORKING PAPERS SERIES IN THEORETICAL AND APPLIED ECONOMICS 201002, University of Kansas, Department of Economics, revised Apr 2010.
  8. Yang, Lu & Hamori, Shigeyuki, 2014. "Spillover effect of US monetary policy to ASEAN stock markets: Evidence from Indonesia, Singapore, and Thailand," Pacific-Basin Finance Journal, Elsevier, vol. 26(C), pages 145-155.
  9. Muhammad, Omer & de Haan, Jakob & Scholtens, Bert, 2014. "An Empirical Analysis of Excess Interbank Liquidity: A Case Study of Pakistan," MPRA Paper 56143, University Library of Munich, Germany.
  10. Stanhouse, Bryan & Schwarzkopf, Al & Ingram, Matt, 2011. "A computational approach to pricing a bank credit line," Journal of Banking & Finance, Elsevier, vol. 35(6), pages 1341-1351, June.
  11. Khemraj, Tarron & Primus, Keyra, 2013. "Testing for the Credit Crunch in Trinidad and Tobago Using an Alternative Method," MPRA Paper 47372, University Library of Munich, Germany.
  12. Muhammad, Omer & de Haan, Jakob & Scholtens, Bert, 2014. "Impact of Interbank Liquidity on Monetary Transmission Mechanism: A Case Study of Pakistan," MPRA Paper 56161, University Library of Munich, Germany.
  13. Lagoarde-Segot, Thomas & Leoni, Patrick L., 2013. "Pandemics of the poor and banking stability," Journal of Banking & Finance, Elsevier, vol. 37(11), pages 4574-4583.
  14. Liu, Ming-Hua & Margaritis, Dimitris & Tourani-Rad, Alireza, 2011. "Asymmetric information and price competition in small business lending," Journal of Banking & Finance, Elsevier, vol. 35(9), pages 2189-2196, September.
  15. Guy, Kester & Lowe, Shane, 2012. "Tracing the Liquidity Effects on Bank Stability in Barbados," MPRA Paper 52205, University Library of Munich, Germany.

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