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Asset prices, collateral and unconventional monetary policy in a DSGE model

  • Hilberg, Björn
  • Hollmayr, Josef
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    In this paper we set up a New-Keynesian model that features an interbank market. The introduction of an interbank market is important to analyze liquidity problems among heterogenous agents within the financial sector. First, because this allows for a situation where increased liquidity supply by the central bank is only partially passed on to the interbank market. Second, this framework allows us to analyze one additional policy measure besides the common interest rate policy undertaken by central banks to alleviate the liquidity shortage on the interbank market. Namely haircuts on eligible assets in repurchase agreements (“Repos”). By varying haircuts applied to securities that serve as collateral in repurchase agreements the stress on the interbank market can be mitigated by bringing down the interest rate charged among banks. Furthermore an exogenous bubble process is modeled which enables us to examine the effects of a deviation of the market price of capital from its fundamental price. This leads to a discussion whether central banks should ”lean against the wind”, i.e. react to deviations of asset prices in the setting of their policy instrument. Finally, this paper tries to shed some light on the “exit strategy” that a central bank should follow after the asset price bubble bursted and the interbank market begins to work properly again. JEL Classification: E4, E5, E61, G21

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    Paper provided by European Central Bank in its series Working Paper Series with number 1373.

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    Date of creation: Aug 2011
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    Handle: RePEc:ecb:ecbwps:20111373
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    1. Matteo Iacoviello, 2002. "House prices, borrowing constraints and monetary policy in the business cycle," Boston College Working Papers in Economics 542, Boston College Department of Economics, revised 06 Dec 2004.
    2. Michael Woodford & Vasco Curdia, 2010. "The Central Bank's Balance Sheet as an Instrument of Monetary Policy," 2010 Meeting Papers 136, Society for Economic Dynamics.
    3. Bernanke, B. & Gertler, M. & Gilchrist, S., 1998. "The Financial Accelerator in a Quantitative Business Cycle Framework," Working Papers 98-03, C.V. Starr Center for Applied Economics, New York University.
    4. Frank Smets & Raf Wouters, 2002. "An estimated dynamic stochastic general equilibrium model of the euro area," Working Paper Research 35, National Bank of Belgium.
    5. Tobias Adrian & Hyun Song Shin, 2009. "Money, liquidity, and monetary policy," Staff Reports 360, Federal Reserve Bank of New York.
    6. Adam Ashcraft & Nicolae Gârleanu & Lasse Heje Pedersen, 2010. "Two Monetary Tools: Interest Rates and Haircuts," NBER Working Papers 16337, National Bureau of Economic Research, Inc.
    7. Angeloni, Ignazio & Faia, Ester & Winkler, Roland, 2014. "Exit strategies," SAFE Working Paper Series 50, Research Center SAFE - Sustainable Architecture for Finance in Europe, Goethe University Frankfurt.
    8. Ian Christensen & Ali Dib, 2008. "The Financial Accelerator in an Estimated New Keynesian Model," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 11(1), pages 155-178, January.
    9. Christiano, Lawrence & Motto, Roberto & Rostagno, Massimo, 2007. "Shocks, structures or monetary policies? The euro area and US after 2001," Working Paper Series 0774, European Central Bank.
    10. Stephen G. Cecchetti & Hans Genberg & Sushil Wadhwani, 2002. "Asset Prices in a Flexible Inflation Targeting Framework," NBER Working Papers 8970, National Bureau of Economic Research, Inc.
    11. Gertler, Mark & Karadi, Peter, 2011. "A model of unconventional monetary policy," Journal of Monetary Economics, Elsevier, vol. 58(1), pages 17-34, January.
    12. repec:dgr:uvatin:20100057 is not listed on IDEAS
    13. Xavier Freixas & José Jorge, 2008. "The Role of Interbank Markets in Monetary Policy: A Model with Rationing," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(6), pages 1151-1176, 09.
    14. Borgy, V. & Laubach, T. & Mésonnier, J-S. & Renne, J-P., 2011. "Fiscal Sustainability, Default Risk and Euro Area Sovereign Bond Spreads Markets," Working papers 350, Banque de France.
    15. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
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