Banks, Liquidity Management and Monetary Policy

134 Pages Posted: 15 Sep 2014 Last revised: 17 Sep 2014

See all articles by Javier Bianchi

Javier Bianchi

Federal Reserve Banks - Federal Reserve Bank of Minneapolis

Saki Bigio

Columbia Business School - Finance and Economics

Date Written: September 2014

Abstract

We develop a tractable model of banks' liquidity management and the credit channel of monetary policy. Banks finance loans by issuing demand deposits. Loans are illiquid, and transfers of deposits across banks must be settled with reserves in a frictional over the counter market. To mitigate the risk of large withdrawals of deposits, banks hold a precautionary buffer of reserves and government bonds. We show how monetary policy affects the banking system by altering the tradeoff between profiting from lending and incurring greater liquidity risk. We consider two applications of the theory, one involving the connection between the implementation of monetary policy and pass-through to loan rates, and another considering a quantitative decomposition behind the collapse in bank lending during the 2008 financial crisis. Our analysis underscores the importance of liquidity frictions and the functioning of interbank markets for the conduct of monetary policy.

Suggested Citation

Bianchi, Javier and Bigio, Saki, Banks, Liquidity Management and Monetary Policy (September 2014). NBER Working Paper No. w20490, Available at SSRN: https://ssrn.com/abstract=2496246

Javier Bianchi (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Minneapolis ( email )

90 Hennepin Avenue
Minneapolis, MN 55480
United States

Saki Bigio

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

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