The (Unintended?) Consequences of the Largest Liquidity Injection Ever
58 Pages Posted: 9 Feb 2017
Date Written: January 1, 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 incentivized Portuguese banks to purchase short-term domestic government bonds that could be pledged to obtain central bank liquidity. This "collateral trade" effect is large, as banks purchased short-term bonds equivalent to 8.4% of amount outstanding. The resumption of public debt issuance is consistent with a strategic reaction of the debt agency to the observed yield curve steepening.
Keywords: Lender of Last Resort, Sovereign Debt, Unconventional Monetary Policy
JEL Classification: E58, G21, G28, H63
Suggested Citation: Suggested Citation