Financial Crisis, Monetary Base Expansion and Risk

This paper examines the post-2008 European Central Bank's liquidity enhancing policies, namely 'Long Term Refinancing Operations', and the increase of banks' excess reserves that followed. To evaluate this in a quantitative environment, I build a dynamic, general equilibrium model that incorporates financial frictions in both the supply and demand for credit and allows banks to receive liquidity and hold reserves. Results suggest the existence of a risk-shifting channel of monetary policy in the recent ECB operations. Specifically, I show that when the central bank supplies liquidity during turbulent times, banks grant loans to riskier _rms. This increases the firms' default on new credit and worsens the performance of the economy although the banks' health is improved. Additionally, I find that an increase in the riskiness of the non-financial corporations can explain the recent reserve accumulation by the banking system. Lastly, I evaluate the effects of negative interest rates on credit and assess the welfare implications of the recent policies.