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Interbank market liquidity and central bank intervention

  • Allen, Franklin
  • Carletti, Elena
  • Gale, Douglas

We develop a simple model of the interbank market where banks trade a long term, safe asset. When there is a lack of opportunities for banks to hedge idiosyncratic and aggregate liquidity shocks, the interbank market is characterized by excessive price volatility. In such a situation, a central bank can implement the constrained efficient allocation by using open market operations to fix the short term interest rate. It can be constrained efficient for banks to hoard liquidity and stop trading with each other if there is sufficient uncertainty about aggregate liquidity demand compared to idiosyncratic liquidity demand.

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File URL: http://www.sciencedirect.com/science/article/pii/S0304-3932(09)00061-0
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Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 56 (2009)
Issue (Month): 5 (July)
Pages: 639-652

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Handle: RePEc:eee:moneco:v:56:y:2009:i:5:p:639-652
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505566

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  1. Allen, Franklin & Carletti, Elena, 2006. "Credit risk transfer and contagion," Journal of Monetary Economics, Elsevier, vol. 53(1), pages 89-111, January.
  2. Viral Acharya & Tanju Yorulmazer, 2007. "Cash-in-the-market pricing and optimal resolution of bank failures," Bank of England working papers 328, Bank of England.
  3. Allen, Franklin & Carletti, Elena, 2006. "Mark-to-market accounting and liquidity pricing," CFS Working Paper Series 2006/17, Center for Financial Studies (CFS).
  4. Rafael Repullo, 2005. "Liquidity, Risk Taking, and the Lender of Last Resort," International Journal of Central Banking, International Journal of Central Banking, vol. 1(2), September.
  5. Marvin Goodfriend & Robert G. King, 1988. "Financial deregulation, monetary policy, and central banking," Working Paper 88-01, Federal Reserve Bank of Richmond.
  6. Douglas W. Diamond & Raghuram G. Rajan, 2005. "Liquidity Shortages and Banking Crises," Journal of Finance, American Finance Association, vol. 60(2), pages 615-647, 04.
  7. Franklin Allen & Douglas Gale, 2004. "Financial Intermediaries and Markets," Econometrica, Econometric Society, vol. 72(4), pages 1023-1061, 07.
  8. Marvin Goodfriend, 2002. "Interest on reserves and monetary policy," Economic Policy Review, Federal Reserve Bank of New York, issue May, pages 77-84.
  9. Viral V. Acharya & Denis Gromb & Tanju Yorulmazer, 2012. "Imperfect Competition in the Interbank Market for Liquidity as a Rationale for Central Banking," American Economic Journal: Macroeconomics, American Economic Association, vol. 4(2), pages 184-217, April.
  10. Bengt Holmstrom & Jean Tirole, 1996. "Private and Public Supply of Liquidity," NBER Working Papers 5817, National Bureau of Economic Research, Inc.
  11. Mark J. Flannery, 1996. "Financial crises, payment system problems, and discount window lending," Proceedings, Board of Governors of the Federal Reserve System (U.S.), pages 804-831.
  12. Gary Gorton & Lixin Huang, 2004. "Liquidity, Efficiency, and Bank Bailouts," American Economic Review, American Economic Association, vol. 94(3), pages 455-483, June.
  13. Xavier Freixas & José Jorge, 2007. "The role of interbank markets in monetary policy: A model with rationing," Economics Working Papers 1027, Department of Economics and Business, Universitat Pompeu Fabra, revised Apr 2008.
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