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The role of interbank markets in monetary policy: A model with rationing

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  • Xavier Freixas

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  • José Jorge

Abstract

This paper analyses the impact of asymmetric information in the interbank market and establishes its crucial role in the microfoundations of the monetary policy transmission mechanism. We show that interbank market imperfections induce an equilibrium with rationing in the credit market. This has two major implications: first, it reconciles the irresponsiveness of business investment to the user cost of capital with the large impact of monetary policy (magnitude effect) and, second, it shows that banks’ liquidity positions condition their reaction to monetary policy (Kashyap and Stein liquidity effect).

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Bibliographic Info

Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 1027.

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Date of creation: Mar 2007
Date of revision: Apr 2008
Handle: RePEc:upf:upfgen:1027

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Web page: http://www.econ.upf.edu/

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Keywords: Banking; Rationing; Monetary Policy;

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  1. Douglas W. Diamond & Raghuram G. Rajan, . "Liquidity Risk, Liquidity Creation and Financial Fragility: A Theory of Banking," CRSP working papers, Center for Research in Security Prices, Graduate School of Business, University of Chicago 476, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  2. Akerlof, George A, 1970. "The Market for 'Lemons': Quality Uncertainty and the Market Mechanism," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 84(3), pages 488-500, August.
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  4. Bernanke, Ben & Gertler, Mark, 1995. "Inside the Black Box: The Credit Channel of Monetary Policy Transmission," Working Papers, C.V. Starr Center for Applied Economics, New York University 95-15, C.V. Starr Center for Applied Economics, New York University.
  5. Ignazio Angeloni & Anil K. Kashyap & Benoît Mojon & Daniele Terlizzese, 2003. "The output composition puzzle: a difference in the monetary transmission mechanism in the euro area and United States," Proceedings, Federal Reserve Bank of Cleveland, Federal Reserve Bank of Cleveland, pages 1265-1317.
  6. Bernanke, Ben & Gertler, Mark, 1990. "Financial Fragility and Economic Performance," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 105(1), pages 87-114, February.
  7. Broecker, Thorsten, 1990. "Credit-Worthiness Tests and Interbank Competition," Econometrica, Econometric Society, Econometric Society, vol. 58(2), pages 429-52, March.
  8. Philippe Aghion, Patrick Bolton & Steven Fries, 1999. "Optimal Design of Bank Bailouts: The Case of Transition Economies," Journal of Institutional and Theoretical Economics (JITE), Mohr Siebeck, Tübingen, Mohr Siebeck, Tübingen, vol. 155(1), pages 51-, March.
  9. Stephen G. Cecchetti, 1999. "Legal Structure, Financial Structure, and the Monetary Policy Transmission Mechanism," NBER Working Papers 7151, National Bureau of Economic Research, Inc.
  10. Mojon, Benoît & Kashyap, Anil K. & Angeloni, Ignazio & Terlizzese, Daniele, 2002. "Monetary Transmission in the Euro Area : Where Do We Stand?," Working Paper Series, European Central Bank 0114, European Central Bank.
  11. Joe Peek & Eric S. Rosengren, 1995. "Is bank lending important for the transmission of monetary policy? An overview," New England Economic Review, Federal Reserve Bank of Boston, Federal Reserve Bank of Boston, issue Nov, pages 3-11.
  12. Ben Bernanke, 1990. "The Federal Funds Rate and the Channels of Monetary Transnission," NBER Working Papers 3487, National Bureau of Economic Research, Inc.
  13. Berger, Allen N & Udell, Gregory F, 1992. "Some Evidence on the Empirical Significance of Credit Rationing," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 100(5), pages 1047-77, October.
  14. Boot, Arnoud W. A., 2000. "Relationship Banking: What Do We Know?," Journal of Financial Intermediation, Elsevier, Elsevier, vol. 9(1), pages 7-25, January.
  15. Hans Degryse & Steven Ongena, 2005. "Distance, Lending Relationships, and Competition," Journal of Finance, American Finance Association, American Finance Association, vol. 60(1), pages 231-266, 02.
  16. Adam B. Ashcraft, 2001. "New evidence on the lending channel," Staff Reports, Federal Reserve Bank of New York 136, Federal Reserve Bank of New York.
  17. Skander Van den Heuvel, 2006. "The Bank Capital Channel of Monetary Policy," 2006 Meeting Papers, Society for Economic Dynamics 512, Society for Economic Dynamics.
  18. Yanelle, Marie-Odile, 1997. "Banking Competition and Market Efficiency," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 64(2), pages 215-39, April.
  19. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, American Economic Association, vol. 71(3), pages 393-410, June.
  20. Sean Cleary, 1999. "The Relationship between Firm Investment and Financial Status," Journal of Finance, American Finance Association, American Finance Association, vol. 54(2), pages 673-692, 04.
  21. Jeremy C. Stein, 1995. "An Adverse Selection Model of Bank Asset and Liability Management with Implications for the Transmission of Monetary Policy," NBER Working Papers 5217, National Bureau of Economic Research, Inc.
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