Working Paper: NBER ID: w25319
Authors: Fiorella De Fiore; Marie Hoerova; Harald Uhlig
Abstract: During the financial and sovereign debt crises, euro area interbank money markets underwent dramatic changes: the share of unsecured borrowing declined throughout the euro area, while private market haircuts on sovereign bonds and bank borrowing from the European Central Bank increased in the South. We construct a quantitative general equilibrium model to evaluate the macroeconomic impact of these developments and the associated policy response. Our model features heterogeneous banks and sovereign bonds, secured and unsecured money markets, and a central bank. We compare a benchmark policy—the central bank providing collateralized lending to banks at haircuts lower than the market—to an alternative policy that maintains a constant central bank balance sheet. We show that the fall in output, investment, and capital would have been twice as high under the alternative policy. More generally, the model allows the analysis of monetary policy tools beyond interest rate policies and quantitative easing.
Keywords: money markets; collateral; monetary policy
JEL Codes: E44; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| secured and unsecured money market frictions (E44) | divert resources into unproductive but liquid assets (G19) |
| secured and unsecured money market frictions (E44) | delever (Y60) |
| delever (Y60) | reduction in lending and output (F65) |
| tight liquidity constraints (E51) | slack leverage constraints (D20) |
| slack leverage constraints (D20) | significant declines in lending and output (F65) |
| central bank policies (E58) | mitigate declines in lending and output (E44) |
| central bank interventions (E58) | improvements in lending and output (G21) |
| central bank policies (E58) | alleviate negative impacts of market frictions (D47) |
| differences in output (C67) | around 2% between various scenarios of bank connectivity and haircut levels (F65) |