Working Paper: CEPR ID: DP13335
Authors: Harald Uhlig; Fiorella De Fiore; Marie Hoerova
Abstract: Interbank money markets have been subject to substantial impairments in the recent decade, such as a decline in unsecured lending and substantial increases in haircuts on posted collateral. This paper seeks to understand the implications of these developments for the broader economy and monetary policy. To that end, we develop a novel general equilibrium model featuring heterogeneous banks, interbank markets for both secured and unsecured credit, and a central bank. The model features a number of occasionally binding constraints. The interactions between these constraints - in particular leverage and liquidity constraints - are key in determining macroeconomic outcomes. We find that both secured and unsecured money market frictions force banks to either divert resources into unproductive but liquid assets or to de-lever, which leads to less lending and output. If the liquidity constraint is very tight, the leverage constraint may turn slack. In this case, there are large declines in lending and output. We show how central bank policies which increase the size of the central bank balance sheet can attenuate this decline.
Keywords: money markets; collateral; monetary policy; balance sheet policies
JEL Codes: E44; E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| money market frictions (E44) | reduced lending (G21) |
| money market frictions (E44) | reduced output (E23) |
| liquidity constraints very tight (G33) | leverage constraints may slacken (G32) |
| leverage constraints slacken (D24) | substantial declines in lending (G21) |
| leverage constraints slacken (D24) | substantial declines in output (E23) |
| central bank policies (E58) | alleviate negative effects (E71) |
| open market asset purchases (E44) | mitigate output declines (E23) |
| varying private-sector haircuts (L84) | significant impact on output (F69) |