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Creator: Bianchi, Javier and Bigio, Saki Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 503 Abstract:
We develop a new tractable model of banks' liquidity management and the credit channel of monetary policy. Banks finance loans by issuing demand deposits. Because loans are illiquid, deposit transfers across banks must be settled with reserves. Deposit withdrawals are random, and banks manage liquidity risk by holding a precautionary buffer of reserves. We show how different shocks affect the banking system by altering the trade-off between profiting from lending and incurring greater liquidity risk. Through various tools, monetary policy affects the real economy by altering that trade-off. In a quantitative application, we study the driving forces behind the decline in lending and liquidity hoarding by banks during the 2008 financial crisis. Our analysis underscores the importance of disruptions in interbank markets followed by a persistent decline in credit demand.
Palavra-chave: Capital requirements, Monetary policy, Liquidity, and Banks Sujeito: E52 - Monetary Policy, E44 - Financial Markets and the Macroeconomy, E51 - Money Supply; Credit; Money Multipliers, and G10 - General Financial Markets: General (includes Measurement and Data)
Creator: Lagos, Ricardo and Rocheteau, Guillaume Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 408 Abstract:
We develop a search-theoretic model of financial intermediation and use it to study how trading frictions affect the distribution of asset holdings, asset prices, efficiency, and standard measures of liquidity. A distinctive feature of our theory is that it allows for unrestricted asset holdings, so market participants can accommodate trading frictions by adjusting their asset positions. We show that these individual responses of asset demands constitute a fundamental feature of illiquid markets: they are a key determinant of bid-ask spreads, trade volume, and trading delays—all the dimensions of market liquidity that search-based theories seek to explain.
This paper is an extension of Ricardo Lagos’s work while he was in the Research Department of the Federal Reserve Bank of Minneapolis.
Palavra-chave: Execution delay, Liquidity, Trade volume, Bid-ask spread, and Search Sujeito: D83 - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness and D10 - Household Behavior: General
Creator: Diamond, Douglas W. and Dybvig, Philip H. Series: Quarterly review (Federal Reserve Bank of Minneapolis. Research Department) Number: Vol. 24, No. 1 Abstract:
This article develops a model which shows that bank deposit contracts can provide allocations superior to those of exchange markets, offering an explanation of how banks subject to runs can attract deposits. Investors face privately observed risks which lead to a demand for liquidity. Traditional demand deposit contracts which provide liquidity have multiple equilibria, one of which is a bank run. Bank runs in the model cause real economic damage, rather than simply reflecting other problems. Contracts which can prevent runs are studied, and the analysis shows that there are circumstances when government provision of deposit insurance can produce superior contracts.
Creator: Shimer, Robert and Werning, Ivan Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 366 Abstract:
We study the optimal design of unemployment insurance for workers sampling job opportunities over time. We focus on the optimal timing of benefits and the desirability of allowing workers to freely access a riskless asset. When workers have constant absolute risk aversion preferences, it is optimal to use a very simple policy: a constant benefit during unemployment, a constant tax during employment that does not depend on the duration of the spell, and free access to savings using a riskless asset. Away from this benchmark, for constant relative risk aversion preferences, the welfare gains of more elaborate policies are minuscule. Our results highlight two largely distinct roles for policy toward the unemployed: (a) ensuring workers have sufficient liquidity to smooth their consumption; and (b) providing unemployment benefits that serve as insurance against the uncertain duration of unemployment spells.
Palavra-chave: Sequential search, Consumption smoothing, Optimal unemployment insurance, and Duration of unemployment benefits Sujeito: J64 - Unemployment: Models, Duration, Incidence, and Job Search, J65 - Unemployment Insurance; Severance Pay; Plant Closings, and D81 - Criteria for Decision-Making under Risk and Uncertainty
Creator: Lagos, Ricardo and Zhang, Shengxing Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 734 Abstract:
We provide empirical evidence of a novel liquidity-based transmission mechanism through which monetary policy influences asset markets, develop a model of this mechanism, and assess the ability of the quantitative theory to match the evidence.
Palavra-chave: Asset prices, Monetary policy, Monetary transmission, and Liquidity Sujeito: E52 - Monetary Policy, D83 - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness, and G12 - Asset Pricing; Trading Volume; Bond Interest Rates
Creator: Buera, Francisco and Nicolini, Juan Pablo Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 714 Abstract:
We study a model with heterogeneous producers that face collateral and cash-in-advance constraints. These two frictions give rise to a nontrivial financial market in a monetary economy. A tightening of the collateral constraint results in a recession generated by a credit crunch. The model can be used to study the effects on the main macroeconomic variables, and on the welfare of each individual of alternative monetary and fiscal policies following the credit crunch. The model reproduces several features of the recent financial crisis, such as the persistent negative real interest rates, the prolonged period at the zero bound for the nominal interest rate, and the collapse in investment and low inflation in spite of the very large increases in liquidity adopted by the government. The policy implications are in sharp contrast to the prevalent view in most central banks, which is based on the New Keynesian explanation of the liquidity trap.
Palavra-chave: Ricardian equivalence, Monetary policy, Credit crunch, Collateral constraints, and Liquidity trap Sujeito: E58 - Central Banks and Their Policies, E52 - Monetary Policy, E44 - Financial Markets and the Macroeconomy, and E63 - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
Creator: Lagos, Ricardo Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 373 Abstract:
I develop an asset-pricing model in which financial assets are valued for their liquidity—the extent to which they are useful in facilitating exchange—as well as for being claims to streams of consumption goods. The implications for average asset returns, the equity-premium puzzle and the risk-free rate puzzle, are explored in a version of the model that nests the work of Mehra and Prescott (1985).
Palavra-chave: Equity Premium, Exchange, Risk-Free Rate, Asset Pricing, and Liquidity Sujeito: E52 - Monetary Policy, D42 - Market Structure, Pricing, and Design: Monopoly, and G12 - Asset Pricing; Trading Volume; Bond Interest Rates
Creator: Buera, Francisco and Nicolini, Juan Pablo Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 540 Abstract:
We study a model with heterogeneous producers that face collateral and cash-in-advance constraints. A tightening of the collateral constraint results in a credit-crunch-generated recession that reproduces several features of the ﬁnancial crisis that unraveled in 2007 in the United States. The model can be used to study the effects of the credit-crunch on the main macroeconomic variables and the impact of alternative policies. The policy implications regarding forward guidance are in contrast with the prevalent view in most central banks, based on the New Keynesian explanation of the liquidity trap.
Palavra-chave: Ricardian equivalence, Credit crunch, Collateral constraints, Liquidity trap, and Monetary policy Sujeito: E52 - Monetary Policy, E44 - Financial Markets and the Macroeconomy, E63 - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy, and E58 - Central Banks and Their Policies
Creator: Christiano, Lawrence J. Series: Quarterly review (Federal Reserve Bank of Minneapolis. Research Department) Number: Vol. 15, No. 1 Abstract:
There is widespread agreement that a surprise increase in an economy's money supply drives the nominal interest rate down and economic activity up, at least in the short run. This is understood as reflecting the dominance of the liquidity effect of a money shock over an opposing force, the anticipated inflation effect. This paper illustrates why standard general equilibrium models have trouble replicating the dominant liquidity effect. It also studies several factors which have the potential to improve the performance of these models.
Creator: Christiano, Lawrence J. and Eichenbaum, Martin S. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 150 Abstract:
Several recent papers provide strong empirical support for the view that an expansionary monetary policy disturbance generates a persistent decrease in interest rates and a persistent increase in output and employment. Existing quantitative general equilibrium models, which allow for capital accumulation, are inconsistent with this view. There does exist a recently developed class of general equilibrium models which can rationalize the contemporaneous response of interest rates, output, and employment to a money supply shock. However, a key shortcoming of these models is that they cannot rationalize persistent liquidity effects. This paper discusses the basic frictions and mechanisms underlying this new class of models and investigates one avenue for generating persistence. We argue that once a simplified version of the model in Christiano and Eichenbaum (1991) is modified to allow for extremely small costs of adjusting sectoral flow of funds, positive money shocks generate long-lasting, quantitatively significant liquidity effects, as well as persistent increases in aggregate economic activity.