The (Unintended?) Consequences of the Largest Liquidity Injection Ever

45 Pages Posted: 21 Apr 2015 Last revised: 21 Nov 2017

See all articles by Matteo Crosignani

Matteo Crosignani

Federal Reserve Banks - Federal Reserve Bank of New York

Miguel Faria-e-Castro

Federal Reserve Bank of St. Louis

Luís Fonseca

London Business School - Department of Economics

Multiple version iconThere are 4 versions of this paper

Date Written: November 20, 2017

Abstract

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

Crosignani, Matteo and Faria-e-Castro, Miguel and Fonseca, Luís, The (Unintended?) Consequences of the Largest Liquidity Injection Ever (November 20, 2017). Available at SSRN: https://ssrn.com/abstract=2595786 or http://dx.doi.org/10.2139/ssrn.2595786

Matteo Crosignani (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

Miguel Faria-e-Castro

Federal Reserve Bank of St. Louis ( email )

411 Locust St
Saint Louis, MO 63011
United States

Luís Fonseca

London Business School - Department of Economics ( email )

Sussex Place
Regent's Park
London NW1 4SA
United Kingdom

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