Working Paper: NBER ID: w20490
Authors: Javier Bianchi; Saki Bigio
Abstract: We develop a tractable model of banks' liquidity management and the credit channel of monetary policy. Banks finance loans by issuing demand deposits. Loans are illiquid, and transfers of deposits across banks must be settled with reserves in a frictional over the counter market. To mitigate the risk of large withdrawals of deposits, banks hold a precautionary buffer of reserves and government bonds. We show how monetary policy affects the banking system by altering the tradeoff between profiting from lending and incurring greater liquidity risk. We consider two applications of the theory, one involving the connection between the implementation of monetary policy and pass-through to loan rates, and another considering a quantitative decomposition behind the collapse in bank lending during the 2008 financial crisis. Our analysis underscores the importance of liquidity frictions and the functioning of interbank markets for the conduct of monetary policy.
Keywords: Monetary Policy; Liquidity Management; Banking System; Credit Channel
JEL Codes: E0; E4; E51; E52; G01; G11; G18; G20; G21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Monetary policy (E52) | Tradeoff between lending profitability and liquidity risk (G21) |
| Monetary policy (E52) | Liquidity premia (G19) |
| Liquidity premia (G19) | Supply of bank credit (E51) |
| Monetary policy (E52) | Loan rates (E43) |
| Liquidity conditions (E41) | Credit crunch during the 2008 financial crisis (G01) |
| Interbank market disruptions (F65) | Credit crunch during the 2008 financial crisis (G01) |
| Conventional open market operations (E52) | Credit availability (G21) |
| Unconventional operations (Y50) | Mitigation of credit crunch (E51) |