Banks, Liquidity Management and Mon etary Policy (with Javier Bianchi)
Abstract:
We develop a new framework to study the transmission of
monetary policy through the banking system. Banks finance illiquid loans b
y issuing deposits. Deposit transfers across banks must be settled using ce
ntral bank reserves. Transfers are random and therefore create liquidity ri
sk, which in turn determines the supply of credit and the money multiplier.
We study how different shocks to the banking system and monetary policy af
fect the economy by altering the trade-o between profiting from lending and
incurring greater liquidity risk. We calibrate our model to study quantita
tively why banks have recently increased their reserve holdings but have no
t expanded lending despite policy e orts. Our analysis underscores an impor
tant role of disruptions in interbank markets, followed by a persistent cre
dit demand shock.