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The (Unintended?) Consequences of the Largest Liquidity Injection Ever

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  • Matteo Crosignani
  • Miguel Faria-e-Castro
  • Luis Fonseca

Abstract

The design of lender-of-last-resort interventions can exacerbate the bank-sovereign nexus. During sovereign crises, central bank provision of long-term liquidity incentivizes banks to purchase high yield eligible collateral securities matching the maturity of the central bank loans. Using unique security level data, we find that the European Central Bank?s 3-year Long-Term Refinancing Operation caused Portuguese banks to purchase short-term domestic government bonds, equivalent to 10.6% of amounts outstanding, and pledge them to obtain central bank liquidity. The steepening of Eurozone peripheral sovereign yield curves right after the policy announcement is consistent with the equilibrium effects of this ?collateral trade.?

Suggested Citation

  • Matteo Crosignani & Miguel Faria-e-Castro & Luis Fonseca, 2017. "The (Unintended?) Consequences of the Largest Liquidity Injection Ever," Working Papers 2017-39, Federal Reserve Bank of St. Louis, revised 30 Jan 2019.
  • Handle: RePEc:fip:fedlwp:2017-039
    DOI: 10.20955/wp.2017.039
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    References listed on IDEAS

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    More about this item

    Keywords

    Lender of Last Resort; Bank-Sovereign Nexus; Collateral; Sovereign Debt; Eurozone Crisis;

    JEL classification:

    • 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
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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