Money Markets, Collateral and Monetary Policy

67 Pages Posted: 22 Nov 2018

See all articles by Fiorella De Fiore

Fiorella De Fiore

Bank for International Settlements (BIS) - Monetary and Economic Department

Marie Hoerova

European Central Bank (ECB); Centre for Economic Policy Research (CEPR)

Harald Uhlig

University of Chicago - Department of Economics

Multiple version iconThere are 4 versions of this paper

Date Written: November 21, 2018

Abstract

Interbank money markets have been subject to substantial impairments in the recent decade, such as a decline in unsecured lending and substantial increases in haircuts on posted collateral. This paper seeks to understand the implications of these developments for the broader economy and monetary policy. To that end, we develop a novel general equilibrium model featuring heterogeneous banks, interbank markets for both secured and unsecured credit, and a central bank. The model features a number of occasionally binding constraints. The interactions between these constraints - in particular leverage and liquidity constraints - are key in determining macroeconomic outcomes. We find that both secured and unsecured money market frictions force banks to either divert resources into unproductive but liquid assets or to de-lever, which leads to less lending and output. If the liquidity constraint is very tight, the leverage constraint may turn slack. In this case, there are large declines in lending and output. We show how central bank policies which increase the size of the central bank balance sheet can attenuate this decline.

Suggested Citation

De Fiore, Fiorella and Hoerova, Marie and Uhlig, Harald, Money Markets, Collateral and Monetary Policy (November 21, 2018). University of Chicago, Becker Friedman Institute for Economics Working Paper No. 2018-79. Available at SSRN: https://ssrn.com/abstract=3288767 or http://dx.doi.org/10.2139/ssrn.3288767

Fiorella De Fiore

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

Marie Hoerova

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Harald Uhlig (Contact Author)

University of Chicago - Department of Economics ( email )

1101 East 58th Street
Chicago, IL 60637
United States

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