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Liquidity Regulation, the Central Bank, and the Money Market

  • Scheubel, Beatrice
  • Körding, Julia
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    As reliance on excessively short-term wholesale funding has been one of the major causes for the 2007-2009 financial crisis, recent advances in global liquidity regulation try to curb the excessive reliance on short-term wholesale funding without being clear on how such an approach will affect the overall equilibrium on money markets. In particular, liquidity regulation may interfere with the central bank's influence on short-term money market rates. This paper tries to fill the gap in understanding the interaction between the money market, the central bank, and the regulator. Importantly, it shows that the existence of a central bank can be welfare-improving when the market equilibrium is driven by collateral constraints and asymmetric information. Regulation can be welfare-improving in the presence of an externality and also in case of collateral constraints, but reduces activity on the unsecured market. This implies that in case of collateral constraints the regulator can lead to a complete crowding out of the unsecured market which leads to an increased central bank intermediation need.

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    Paper provided by Verein für Socialpolitik / German Economic Association in its series Annual Conference 2013 (Duesseldorf): Competition Policy and Regulation in a Global Economic Order with number 79754.

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    Date of creation: 2013
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    Handle: RePEc:zbw:vfsc13:79754
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    1. John B. Taylor & John C. Williams, 2009. "A black swan in the money market," Proceedings, Federal Reserve Bank of San Francisco, issue Jan.
    2. Rafael Repullo, 2005. "Liquidity, Risk-Taking, And The Lender Of Last Resort," Working Papers wp2005_0504, CEMFI.
    3. Flannery, Mark J, 1986. " Asymmetric Information and Risky Debt Maturity Choice," Journal of Finance, American Finance Association, vol. 41(1), pages 19-37, March.
    4. John Taylor & John Williams, 2008. "Further Results on a Black Swan in the Money Market," Discussion Papers 07-046, Stanford Institute for Economic Policy Research.
    5. Enrico Perotti & Javier Suarez, 2011. "A Pigovian Approach to Liquidity Regulation," DNB Working Papers 291, Netherlands Central Bank, Research Department.
    6. repec:tpr:qjecon:v:106:y:1991:i:3:p:709-37 is not listed on IDEAS
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