Unintended Consequences of Central Bank Lending in Financial Crises

I investigate the macroeconomic impact of central bank funding becoming a more attractive funding source to financial intermediaries in times of crisis. I show that the requirement to pledge collateral has a contractionary effect on private credit, everything else equal, and thereby reduces the expansionary effect that such lending otherwise has. I use an estimated New Keynesian model with financial frictions to show that the collateral effect explains the limited growth of Italian banks’ private credit in response to the European Central Bank’s three-year longer-term refinancing operations. Finally, I explore whether changes in lending policy can offset the cumulative negative effects from the collateral effect.