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Banks, Liquidity Management and Monetary Policy

Author

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  • Javier Bianchi
  • Saki Bigio

Abstract

We develop a new tractable model of banks' liquidity management and the credit channel of monetary policy. Banks finance loans by issuing demand deposits. Because loans are illiquid, deposit transfers across banks must be settled with reserves. Deposit withdrawals are random, and banks manage liquidity risk by holding a precautionary buffer of reserves. We show how different shocks affect the banking system by altering the trade-off between profiting from lending and incurring greater liquidity risk. Through various tools, monetary policy affects the real economy by altering that trade-off. In a quantitative application, we study the driving forces behind the decline in lending and liquidity hoarding by banks during the 2008 financial crisis. Our analysis underscores the importance of disruptions in interbank markets followed by a persistent decline in credit demand.

Suggested Citation

  • Javier Bianchi & Saki Bigio, 2014. "Banks, Liquidity Management and Monetary Policy," NBER Working Papers 20490, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:20490
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    References listed on IDEAS

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    1. Armantier, Olivier & Ghysels, Eric & Sarkar, Asani & Shrader, Jeffrey, 2015. "Discount window stigma during the 2007–2008 financial crisis," Journal of Financial Economics, Elsevier, vol. 118(2), pages 317-335.
    2. Saki Bigio, 2015. "Endogenous Liquidity and the Business Cycle," American Economic Review, American Economic Association, vol. 105(6), pages 1883-1927, June.
    3. Smets, Frank & Collard, Fabrice & Boissay, Frédéric, 2013. "Booms and systemic banking crises," Working Paper Series 1514, European Central Bank.
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    Citations

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    Cited by:

    1. Hugo Rodríguez Mendizábal, 2017. "Narrow Banking with Modern Depository Institutions: Is there a Reason to Panic?," Working Papers 955, Barcelona Graduate School of Economics.
    2. Marcelo Rezende & Mary-Frances Styczynski & Cindy M. Vojtech, 2016. "The Effects of Liquidity Regulation on Bank Demand in Monetary Policy Operations," Finance and Economics Discussion Series 2016-090, Board of Governors of the Federal Reserve System (U.S.).
    3. Williamson, Stephen D., 2015. "Interest on Reserves, Interbank Lending, and Monetary Policy," Working Papers 2015-24, Federal Reserve Bank of St. Louis.
    4. Benjamin Lester & Roc Armenter, 2015. "Excess Reserves and Monetary Policy Normalization," 2015 Meeting Papers 586, Society for Economic Dynamics.
    5. Kieran Walsh, 2014. "Portfolio Choice and Partial Default in Emerging Markets: a quantitative analysis," 2014 Meeting Papers 789, Society for Economic Dynamics.
    6. Chen, Kaiji & Ren, Jue & Zha, Tao, 2016. "What we learn from China's rising shadow banking: exploring the nexus of monetary tightening and banks' role in entrusted lending," FRB Atlanta Working Paper 2016-1, Federal Reserve Bank of Atlanta.
    7. Butt, Nick & Churm, Rohan & McMahon, Michael & Morotz, Arpad & Schanz, Jochen, 2014. "QE and the bank lending channel in the United Kingdom," Bank of England working papers 511, Bank of England.
    8. Kandrac, John & Schlusche, Bernd, 2017. "Quantitative Easing and Bank Risk Taking: Evidence from Lending," Finance and Economics Discussion Series 2017-125, Board of Governors of the Federal Reserve System (U.S.).
    9. Keister, Todd & Martin, Antoine & McAndrews, James J., 2015. "Floor systems and the Friedman rule: the fiscal arithmetic of open market operations," Staff Reports 754, Federal Reserve Bank of New York.
    10. Guillaume Khayat, 2017. "The Corridor's Width as a Monetary Policy Tool," Working Papers halshs-01611650, HAL.
    11. Narayan Bulusu & Pierre Guérin, 2018. "What Drives Interbank Loans? Evidence from Canada," Staff Working Papers 18-5, Bank of Canada.
    12. Choi, Dong Boem & Choi, Hyun-Soo, 2016. "The effect of monetary policy on bank wholesale funding," Staff Reports 759, Federal Reserve Bank of New York, revised 01 Apr 2017.
    13. Ken Kuttner & James Yetman, 2016. "A comparison of liquidity management tools in seven Asian economies," BIS Papers chapters,in: Bank for International Settlements (ed.), Expanding the boundaries of monetary policy in Asia and the Pacific, volume 88, pages 33-58 Bank for International Settlements.
    14. Stefan Nagel, 2016. "The Liquidity Premium of Near-Money Assets," The Quarterly Journal of Economics, Oxford University Press, vol. 131(4), pages 1927-1971.
    15. Pérez-Forero, Fernando & Vega, Marco, 2014. "The Dynamic Effects of Interest Rates and Reserve Requirements," Working Papers 2014-018, Banco Central de Reserva del Perú.
    16. repec:cml:moneta:v:iv:y:2016:i:2:p:153-193 is not listed on IDEAS

    More about this item

    JEL classification:

    • E0 - Macroeconomics and Monetary Economics - - General
    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • 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
    • G01 - Financial Economics - - General - - - Financial Crises
    • G1 - Financial Economics - - General Financial Markets
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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