Public Liquidity and Financial Crises

65 Pages Posted: 24 Jun 2018 Last revised: 17 Nov 2021

See all articles by Wenhao Li

Wenhao Li

University of Southern California - Marshall School of Business

Date Written: December 28, 2019

Abstract

This paper studies the equilibrium effect of public liquidity on financial crises. Banks borrow from households via insured deposits and partially runnable debt, and suffer endogenous funding withdrawals from households in crises. Holding public liquidity alleviates banks' liquidity problems. In equilibrium, a larger public liquidity supply reduces crisis severity, expands bank lending, but crowds bank deposits and increases bank vulnerability to real shocks. The model quantitatively explains 40% of Treasury liquidity premium variations. Counterfactual analyses reveal that QE1 significantly improves output, 20 times larger than QE3. However, QE infinity during COVID-19 increases bank fragility to real shocks and reduces output.

Keywords: public liquidity, financial crisis, liquidity premium, banking

JEL Classification: E44, E58, G10, G28

Suggested Citation

Li, Wenhao, Public Liquidity and Financial Crises (December 28, 2019). USC Marshall School of Business Research Paper, Available at SSRN: https://ssrn.com/abstract=3175101 or http://dx.doi.org/10.2139/ssrn.3175101

Wenhao Li (Contact Author)

University of Southern California - Marshall School of Business ( email )

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HOME PAGE: http://www.wenhao-li.com

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