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Banks, Liquidity Management, and Monetary Policy

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  • Javier Bianchi
  • Saki Bigio

Abstract

We develop a new framework to study the implementation of monetary policy through the banking system. Banks finance illiquid loans by issuing deposits. Deposit transfers across banks must be settled using central bank reserves. Transfers are random and therefore create liquidity risk, which in turn determines the supply of credit and the money multiplier. We study how different shocks to the banking system and monetary policy affect the economy by altering the trade-off between profiting from lending and incurring greater liquidity risk. We calibrate our model to study quantitatively why banks have recently increased their reserve holdings but have not expanded lending despite policy efforts. Our analysis underscores an important role of disruptions in interbank markets, followed by a persistent credit demand shock.

Suggested Citation

  • Javier Bianchi & Saki Bigio, 2014. "Banks, Liquidity Management, and Monetary Policy," Staff Report 503, Federal Reserve Bank of Minneapolis.
  • Handle: RePEc:fip:fedmsr:503
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    More about this item

    Keywords

    Capital requirements; Monetary policy; Liquidity;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G1 - Financial Economics - - General Financial Markets
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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