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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
Date of revision:
Handle: RePEc:cmf:wpaper:wp2009_0901
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  1. Rocco Huang & Lev Ratnovski, 2009. "The dark side of bank wholesale funding," Working Papers 09-3, Federal Reserve Bank of Philadelphia.
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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.
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  17. 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.
  18. Lucas, Robert Jr., 1988. "On the mechanics of economic development," Journal of Monetary Economics, Elsevier, vol. 22(1), pages 3-42, July.
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