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Liquidity Regulation and the Implementation of Monetary Policy

41 Pages Posted: 27 Feb 2014  

Morten L. Bech

Bank for International Settlements (BIS) - Committee on Payments and Market Infrastructures

Todd Keister

Rutgers, The State University of New Jersey - Department of Economics

Date Written: October 2013

Abstract

In addition to revamping existing rules for bank capital, Basel III introduces a new global framework for liquidity regulation. One part of this framework is the liquidity coverage ratio (LCR), which requires banks to hold sufficient high-quality liquid assets to survive a 30-day period of market stress. As monetary policy typically involves targeting the interest rate on loans of one of these assets - central bank reserves - it is important to understand how this regulation may impact the efficacy of central banks' current operational frameworks. We introduce term funding and an LCR requirement into an otherwise standard model of monetary policy implementation. Our model shows that if banks face the possibility of an LCR shortfall, then the usual link between open market operations and the overnight interest rate changes and the short end of the yield curve becomes steeper. Our results suggest that central banks may want to adjust their operational frameworks as the new regulation is implemented.

Keywords: Basel III, Liquidity regulations, LCR, Reserves, Corridor system, Monetary policy

JEL Classification: E43, E52, E58, G28

Suggested Citation

Bech, Morten L. and Keister, Todd, Liquidity Regulation and the Implementation of Monetary Policy (October 2013). BIS Working Paper No. 432. Available at SSRN: https://ssrn.com/abstract=2390173

Morten L. Bech (Contact Author)

Bank for International Settlements (BIS) - Committee on Payments and Market Infrastructures ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland
41612808923 (Phone)

Todd Keister

Rutgers, The State University of New Jersey - Department of Economics ( email )

75 Hamilton Street
New Brunswick, NJ 08901
United States

HOME PAGE: http://econweb.rutgers.edu/tkeister

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