Liquidity Regulation, the Central Bank and the Money Market

Posted: 21 Jun 2013

See all articles by Julia Körding

Julia Körding

European Central Bank (ECB)

Beatrice Scheubel

European Central Bank (ECB); Ludwig Maximilian University of Munich (LMU) - Center for Economic Studies (CES)

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Date Written: March 15, 2013

Abstract

As reliance on excessively short-term wholesale funding has been one of the major causes for the 2007-2009 financial crisis, recent advances in global liquidity regulation try to curb the excessive reliance on short-term wholesale funding without being clear on how such an approach will affect the overall equilibrium on money markets. In particular, liquidity regulation may interfere with the central bank's influence on short-term money market rates.

This paper tries to fill the gap in understanding the interaction between the money market, the central bank, and the regulator. Importantly, it shows that the existence of a central bank can be welfare-improving when the market equilibrium is driven by collateral constraints and asymmetric information. Regulation can be welfare-improving in the presence of an externality and also in case of collateral constraints, but reduces activity on the unsecured market. This implies that in case of collateral constraints the regulator can lead to a complete crowding out of the unsecured market which leads to an increased central bank intermediation need.

Keywords: regulation, Basel III, Pigovian tax, externality, interbank lending, central bank

JEL Classification: E41, E42, E43, E58, H23, L51

Suggested Citation

Körding, Julia and Scheubel, Beatrice, Liquidity Regulation, the Central Bank and the Money Market (March 15, 2013). Available at SSRN: https://ssrn.com/abstract=2282400

Julia Körding

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Beatrice Scheubel (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Ludwig Maximilian University of Munich (LMU) - Center for Economic Studies (CES)

Schackstr. 4
Munich, 80539
Germany

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