The (Unintended?) Consequences of the Largest Liquidity Injection Ever
45 Pages Posted: 21 Apr 2015 Last revised: 21 Nov 2017
Date Written: November 20, 2017
We study the design of lender of last resort interventions and show that the provision of long-term liquidity incentivizes purchases of high-yield short-term securities by banks. Using a unique security-level data set, we find that the European Central Bank’s three-year Long-Term Refinancing Operation caused Portuguese banks to purchase short-term domestic government bonds and pledge them to obtain central bank liquidity. This “collateral trade” effect is large, as banks purchased short-term bonds equivalent to 10.6% of amounts outstanding. The steepening of peripheral sovereign yield curves after the policy announcement is consistent with the equilibrium effects of the collateral trade.
Keywords: Lender of Last Resort; Unconventional Monetary Policy; Sovereign Debt; Bank Portfolio Choice
JEL Classification: E58, G21, G28, H63
Suggested Citation: Suggested Citation