Illiquid Banks, Financial Stability, and Interest Rate Policy
Banks finance illiquid assets with demandable deposits, which discipline bankers but expose them to damaging runs. Authorities may not want to stand by and watch banks collapse. However, unconstrained direct bailouts undermine the disciplinary role of deposits. Moreover, competition forces banks to promise depositors more, increasing intervention and making the system worse off. By contrast, constrained central bank intervention to lower rates maintains private discipline, while offsetting contractual rigidity. It may still lead banks to make excessive liquidity promises. Anticipating this, central banks should raise rates in normal times to offset distortions from reducing rates in adverse times.
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- Xavier Freixas & Antoine Martin & David Skeie, 2010.
"Bank Liquidity, Interbank Markets and Monetary Policy,"
429, Barcelona Graduate School of Economics.
- Xavier Freixas & Antoine Martin & David Skeie, 2011. "Bank Liquidity, Interbank Markets, and Monetary Policy," Review of Financial Studies, Society for Financial Studies, vol. 24(8), pages 2656-2692.
- Xavier Freixas & Antoine Martin & David Skeie, 2009. "Bank liquidity, interbank markets, and monetary policy," Staff Reports 371, Federal Reserve Bank of New York.
- Xavier Freixas & Antoine Martin & David Skeie, 2010. "Bank liquidity, interbank markets and monetary policy," Economics Working Papers 1202, Department of Economics and Business, Universitat Pompeu Fabra.
- Freixas, X. & Martin, A. & Skeie, D., 2010. "Bank Liquidity, Interbank Markets, and Monetary Policy," Discussion Paper 2010-35S, Tilburg University, Center for Economic Research.
- Tobias Adrian & Hyun Song Shin, 2008.
"Financial intermediaries, financial stability, and monetary policy,"
346, Federal Reserve Bank of New York.
- Shin, Hyun Song & Adrian, Tobias, 2008. "Financial intermediaries, financial stability and monetary policy," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 287-334.
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