Bank Intermediation and Persistent Liquidity Effects in the Presence of a Frictionless Bond Market
An "expansionary" monetary policy that increases the growth rate of bank reserves is generally believed by policymakers to induce a "liquidity effect", or a persistent decline in short-term nominal interest rates, that stimulates real activity. Christiano, et al. (1991,1995,1997) have incorporated this feature of the economy into equilibrium business cycle models by introducing a commercial bank that acquires deposits from households and channels those funds to firms, which use them to fund their working capital expenses. Bank deposits are the only interest-bearing financial asset available to households, and bank loans are the only source of working capital finance available to firms. To obtain a liquidity effect in response to an unanticipated reserves injection, those models rely on an information friction whereby households precommit to a liquid asset position prior to the monetary shock. In practice, the capital markets are a major source of working capital finance, and U.S. data indicate that bank financing as a share of total short-term working capital finance is countercyclical.This paper extends this literature by introducing a bond market that allows for nonintermediated loans directly from households to firms, and examines the information friction that could induce liquidity effects and countercyclicality in the degree of bank intermediation of working capital finance. The results indicate that: (i) "sticky prices" are neither necessary nor sufficient to induce a liquidity effect; (ii) deposit precommitment by households along with a presetting of the deposit rate by banks does induce persistent liquidity effects, but results in excess volatility of consumption and investment; (iii) minimizing the deposit precommitment, while maintaining the preset deposit rate induces a weaker liquidity effect that is more in line with the data, without the excess volatility in consumption and investment; and (iv) the share of bank intermediation in working capital finance is countercyclical in all cases, including the absence of an information friction. ( JEL Classifications: E4,E5. Keywords: financial intermediation, liquidity, monetary policy. )
|Date of creation:||Dec 2003|
|Date of revision:|
|Contact details of provider:|| Postal: Kalkofnsvegi 1, 150 Reykjavik|
Web page: http://www.sedlabanki.is/
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Robert N. McCauley & Rama Seth, 1992. "Foreign bank credit to U.S. corporations: the implications of offshore loans," Quarterly Review, Federal Reserve Bank of New York, issue Spr, pages 52-65.
- den Haan, Wouter J & Marcet, Albert, 1990.
"Solving the Stochastic Growth Model by Parameterizing Expectations,"
Journal of Business & Economic Statistics,
American Statistical Association, vol. 8(1), pages 31-34, January.
- Wouter Denhaan & Albert Marcet, 1990. "FORTRAN code for Simulation Parameterized Expecations Algorithm," QM&RBC Codes 57, Quantitative Macroeconomics & Real Business Cycles.
- Lucas, Robert Jr., 1990. "Liquidity and interest rates," Journal of Economic Theory, Elsevier, vol. 50(2), pages 237-264, April.
- Mark S. Carey & Mitchell A. Post & Steven A. Sharpe, 1996.
"Does corporate lending by banks and finance companies differ? Evidence on specialization in private debt contracting,"
Finance and Economics Discussion Series
96-25, Board of Governors of the Federal Reserve System (U.S.).
- Mark Carey & Mitch Post & Steven A. Sharpe, 1998. "Does Corporate Lending by Banks and Finance Companies Differ? Evidence on Specialization in Private Debt Contracting," Journal of Finance, American Finance Association, vol. 53(3), pages 845-878, 06.
- Einarsson, Tor & Marquis, Milton H, 2001. "Bank Intermediation over the Business Cycle," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 33(4), pages 876-99, November.
- Fuerst, Timothy S., 1992. "Liquidity, loanable funds, and real activity," Journal of Monetary Economics, Elsevier, vol. 29(1), pages 3-24, February.
- Kydland, Finn E & Prescott, Edward C, 1982.
"Time to Build and Aggregate Fluctuations,"
Econometric Society, vol. 50(6), pages 1345-70, November.
- Finn E. Kydland & Edward C. Prescott, 1982. "Web interface for "Time to Build and Aggregate Fluctuations"," QM&RBC Codes 4a, Quantitative Macroeconomics & Real Business Cycles.
- Finn E. Kydland & Edward C. Prescott, 1982. "Executable program for "Time to Build and Aggregate Fluctuations"," QM&RBC Codes 4, Quantitative Macroeconomics & Real Business Cycles.
When requesting a correction, please mention this item's handle: RePEc:ice:wpaper:wp21_tor. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Central Bank of Iceland)
If references are entirely missing, you can add them using this form.