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Monetary Policy under Subjective Beliefs of Banks: Optimal Central Bank Collateral Requirements

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  • Florian B¨oser

    (CER–ETH – Center of Economic Research at ETH Zurich, Switzerland)

Abstract

We study how the subjective beliefs about loan repayment on the side of liquidity-constrained banks affect the central bank’s choice of collateral standards in its lending facilities. Optimism on the side of banks, entailing a higher collateral value of bank loans, can lead to excessive lending and bank default. Pessimism, though, can entail insufficient lending and productivity losses. With an appropriate haircut on collateral, the central bank can perfectly neutralize the banks’ belief distortions and always induce the socially optimal allocation. Under uncertainty about beliefs, the central bank’s incentives to set looser collateral standards increase. This reduces the risk of deficient bank lending if sufficiently pessimistic beliefs realize. In extreme cases, monetary policy aims at mitigating productivity losses only, instead of also avoiding bank default.

Suggested Citation

  • Florian B¨oser, 2021. "Monetary Policy under Subjective Beliefs of Banks: Optimal Central Bank Collateral Requirements," CER-ETH Economics working paper series 21/357, CER-ETH - Center of Economic Research (CER-ETH) at ETH Zurich.
    • Handle: RePEc:eth:wpswif:21-357
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    References listed on IDEAS

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    More about this item

    Keywords

    beliefs; collateral; liquidity; central bank; banks;
    All these keywords.

    JEL classification:

    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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