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The Macroeconomics Of Money Market Freezes

  • Max Bruche

    ()

    (CEMFI, Centro de Estudios Monetarios y Financieros)

  • Javier Suarez

    ()

    (CEMFI, Centro de Estudios Monetarios y Financieros)

This paper develops a tractable general equilibrium model in which money markets provide structural funding to some banks. When bank default risk becomes significant, retail deposit insurance creates an asymmetry between banks that operate in savingsrich regions, which can remain financed at cheap risk-free rates, and in savings-poor regions, which have to pay either large spreads in money markets or high rates for the scarce regional savings. We show that this asymmetry can cause a severe distortion of the aggregate allocation of credit. When interdependencies across borrowers are large (e.g., via demand externalities), output and welfare losses are also large and can be dramatically reduced by an aggressive subsidization of money market borrowing. The analysis offers some insights on the rationale for responding to a money markets freeze with full-allotment fixed-rate lending policies by central banks or the extension of government guarantees on non-deposit liabilities.

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Paper provided by CEMFI in its series Working Papers with number wp2009_0901.

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Date of creation: Jun 2009
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Handle: RePEc:cmf:wpaper:wp2009_0901
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  1. Williamson, Stephen D, 1987. "Financial Intermediation, Business Failures, and Real Business Cycles," Journal of Political Economy, University of Chicago Press, vol. 95(6), pages 1196-1216, December.
  2. Césaire Meh & Kevin Moran, 2008. "The Role of Bank Capital in the Propagation of Shocks," Working Papers 08-36, Bank of Canada.
  3. Heider, Florian & Hoerova, Marie & Holthausen, Cornelia, 2009. "Liquidity hoarding and interbank market spreads: the role of counterparty risk," Working Paper Series 1126, European Central Bank.
  4. Bolton, Patrick & Freixas, Xavier, 2001. "Corporate Finance and the Monetary Transmission Mechanism," CEPR Discussion Papers 2892, C.E.P.R. Discussion Papers.
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  6. Repullo, Rafael & Suarez, Javier, 2008. "The Procyclical Effects of Basel II," CEPR Discussion Papers 6862, C.E.P.R. Discussion Papers.
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  9. repec:dgr:kubcen:200940s is not listed on IDEAS
  10. Holmstrom, Bengt & Tirole, Jean, 1997. "Financial Intermediation, Loanable Funds, and the Real Sector," The Quarterly Journal of Economics, MIT Press, vol. 112(3), pages 663-91, August.
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  13. Xavier Freixas & Jean-Charles Rochet, 2008. "Microeconomics of Banking, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 0262062704, June.
  14. Asli Demirguc-Kunt & Enrica Detragiache, 2000. "Does Deposit Insurance Increase Banking System Stability? An Empirical Investigation," Econometric Society World Congress 2000 Contributed Papers 1751, Econometric Society.
  15. Chen, Nan-Kuang, 2001. "Bank net worth, asset prices and economic activity," Journal of Monetary Economics, Elsevier, vol. 48(2), pages 415-436, October.
  16. Lucas, Robert Jr., 1988. "On the mechanics of economic development," Journal of Monetary Economics, Elsevier, vol. 22(1), pages 3-42, July.
  17. Skander Van den Heuvel, 2006. "The Bank Capital Channel of Monetary Policy," 2006 Meeting Papers 512, Society for Economic Dynamics.
  18. 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.
  19. Romer, Paul M, 1986. "Increasing Returns and Long-run Growth," Journal of Political Economy, University of Chicago Press, vol. 94(5), pages 1002-37, October.
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