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Liquidity Risk and Monetary Policy

Author

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  • Sauer, Stephan

Abstract

This paper provides a framework to analyse emergency liquidity assistance of central banks on financial markets in response to aggregate and idiosyncratic liquidity shocks. The model combines the microeconomic view of liquidity as the ability to sell assets quickly and at low costs and the macroeconomic view of liquidity as a medium of exchange that influences the aggregate price level of goods. The central bank faces a trade-off between limiting the negative output effects of dramatic asset price declines and more inflation. Furthermore, the anticipation of central bank intervention causes a moral hazard effect with investors. This gives rise to the possibility of an optimal monetary policy under commitment.

Suggested Citation

  • Sauer, Stephan, 2007. "Liquidity Risk and Monetary Policy," Discussion Papers in Economics 2012, University of Munich, Department of Economics.
    • Handle: RePEc:lmu:muenec:2012
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    File URL: https://epub.ub.uni-muenchen.de/2012/1/liquidity_risk_paper_submission.pdf
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    Citations

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    Cited by:

    1. Romaniuk, Katarzyna & Vranceanu, Radu, 2008. "Asset Prices and Assymetries in the Fed's Interest Rate Rule : a Financial Approach," ESSEC Working Papers DR 08006, ESSEC Research Center, ESSEC Business School.
    2. Söderberg, Jonas, 2008. "Do Macroeconomic Variables Forecast Changes in Liquidity? An Out-of-sample Study on the Order-driven Stock Markets in Scandinavia," CAFO Working Papers 2009:10, Linnaeus University, Centre for Labour Market Policy Research (CAFO), School of Business and Economics.
    3. Charles Kahn, 2013. "Private payment systems, collateral, and interest rates," Annals of Finance, Springer, vol. 9(1), pages 83-114, February.
    4. Gerhard Illing, 2007. "Financial Stability and Monetary Policy – A Framework," CESifo Working Paper Series 1971, CESifo.
    5. Nikolaou, Kleopatra, 2009. "Liquidity (risk) concepts: definitions and interactions," Working Paper Series 1008, European Central Bank.

    More about this item

    Keywords

    Liquidity shocks; Financial crises; Liquidity provision principle; Greenspan put; Optimal monetary policy intervention;
    All these keywords.

    JEL classification:

    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation

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