Bank Liquidity, Interbank Markets, and Monetary Policy

48 Pages Posted: 22 May 2009 Last revised: 8 Apr 2010

See all articles by Xavier Freixas

Xavier Freixas

Universitat Pompeu Fabra; Centre for Economic Policy Research (CEPR); Barcelona Graduate School of Economics (Barcelona GSE)

Antoine Martin

Federal Reserve Bank of New York - Research and Statistics

David R. Skeie

Texas A&M University - Mays Business School - Department of Finance

Date Written: February 28, 2010

Abstract

A major lesson of the recent financial crisis is that the ability of banks to withstand liquidity shocks and to provide lending to one another is crucial for financial stability. This paper studies the functioning of the interbank lending market and the optimal policy of a central bank in response to both idiosyncratic and aggregate shocks. In particular, we consider how the interbank market affects a bank’s choice between holding liquid assets ex ante and acquiring such assets in the market ex post. We show that a central bank should use different tools to manage different types of shocks. Specifically, it should respond to idiosyncratic shocks by lowering the interest rate in the interbank market and address aggregate shocks by injecting liquid assets into the banking system. We also show that failure to adopt the optimal policy can lead to financial fragility.

Keywords: bank liquidity, interbank markets, central bank policy, financial fragility, bank runs

JEL Classification: G21, E43, E52, E58

Suggested Citation

Freixas, Xavier and Martin, Antoine and Skeie, David R., Bank Liquidity, Interbank Markets, and Monetary Policy (February 28, 2010). FRB of New York Staff Report No. 371; European Banking Center Discussion Paper No. 2010-08S; CentER Discussion Paper Series No. 2010-35S. Available at SSRN: https://ssrn.com/abstract=1407255 or http://dx.doi.org/10.2139/ssrn.1407255

Xavier Freixas

Universitat Pompeu Fabra ( email )

Ramon Trias Fargas 25-27
Barcelona, 08005
Spain
+34 93 542 2726 (Phone)
+34 93 542 1746 (Fax)

HOME PAGE: http://www.econ.upf.es/~freixas

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

HOME PAGE: http://www.econ.upf.es/~freixas/more/personal1.htm

Barcelona Graduate School of Economics (Barcelona GSE) ( email )

Ramon Trias Fargas, 25-27
Barcelona, Barcelona 08005
Spain

Antoine Martin (Contact Author)

Federal Reserve Bank of New York - Research and Statistics ( email )

33 Liberty Street
New York, NY 10045
United States
212-720-6943 (Phone)

David R. Skeie

Texas A&M University - Mays Business School - Department of Finance ( email )

360E Wehner
College Station, TX 77843-4218
United States
949-845-1224 (Phone)
979-845-3884 (Fax)

HOME PAGE: http://mays.tamu.edu/directory/drs/

Register to save articles to
your library

Register

Paper statistics

Downloads
821
rank
28,198
Abstract Views
2,967
PlumX Metrics
!

Under construction: SSRN citations will be offline until July when we will launch a brand new and improved citations service, check here for more details.

For more information