The Reserve Supply Channel of Unconventional Monetary Policy

58 Pages Posted: 25 Sep 2020 Last revised: 14 Apr 2021

See all articles by William Diamond

William Diamond

University of Pennsylvania - Finance Department

Zhengyang Jiang

Kellogg School of Management - Department of Finance

Yiming Ma

Columbia University - Columbia Business School

Date Written: September 11, 2020

Abstract

We document the "reserve supply channel" of Quantitative Easing (QE) that has the unintended consequence of reducing bank lending to firms. Each dollar of central bank reserves created by QE crowds out 13 cents of bank lending. We reach this conclusion using a structural model that is estimated with instrumental variables for deposit and loan demand across regions of the country. Our results depend on two key estimates: the elasticity of demand for bank loans and how the cost of supplying loans is impacted by a bank's holding of reserves. We find that each $1 trillion of reserves in the banking system raises the cost of capital for loans by 1.5 basis points, leading to a 3.42% reduction in the quantity of corporate loans demanded. In a counterfactual simulation, we show that the $2.7 trillion of reserves created by QE reduced bank lending to firms by over $500 billion but had modest impacts on deposit and mortgage quantities. Our results imply that forcing the banking sector to hold the large quantity of reserves created by QE reduces QE's ability to stimulate the economy. This unintended consequence of QE could potentially be alleviated by the relaxation of the Supplementary Leverage Ratio (SLR) regulation.

Keywords: Financial Intermediation, Quantitative Easing, Deposit Competition, Balance Sheet Cost, Structural Estimation

JEL Classification: G21, G28

Suggested Citation

Diamond, William and Jiang, Zhengyang and Ma, Yiming, The Reserve Supply Channel of Unconventional Monetary Policy (September 11, 2020). Jacobs Levy Equity Management Center for Quantitative Financial Research Paper, Available at SSRN: https://ssrn.com/abstract=3671160 or http://dx.doi.org/10.2139/ssrn.3671160

William Diamond

University of Pennsylvania - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States

Zhengyang Jiang

Kellogg School of Management - Department of Finance ( email )

Evanston, IL 60208
United States

HOME PAGE: http://sites.google.com/site/jayzedwye/

Yiming Ma (Contact Author)

Columbia University - Columbia Business School ( email )

3022 Broadway
New York, NY 10027
United States

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