Interbank market liquidity and central bank intervention

Franklin Allen, Elena Carletti, Douglas Gale

    Research output: Contribution to journalArticle

    Abstract

    We develop a simple model of the interbank market where banks trade a long term, safe asset. When there is a lack of opportunities for banks to hedge idiosyncratic and aggregate liquidity shocks, the interbank market is characterized by excessive price volatility. In such a situation, a central bank can implement the constrained efficient allocation by using open market operations to fix the short term interest rate. It can be constrained efficient for banks to hoard liquidity and stop trading with each other if there is sufficient uncertainty about aggregate liquidity demand compared to idiosyncratic liquidity demand.

    Original languageEnglish (US)
    Pages (from-to)639-652
    Number of pages14
    JournalJournal of Monetary Economics
    Volume56
    Issue number5
    DOIs
    StatePublished - Jul 2009

    Fingerprint

    Interbank market
    Central bank intervention
    Liquidity
    Market liquidity
    Open market operations
    Aggregate uncertainty
    Liquidity shocks
    Short-term interest rates
    Assets
    Hedge
    Central bank
    Efficient allocation
    Price volatility

    Keywords

    • Constrained efficiency
    • Open market operations

    ASJC Scopus subject areas

    • Economics and Econometrics
    • Finance

    Cite this

    Interbank market liquidity and central bank intervention. / Allen, Franklin; Carletti, Elena; Gale, Douglas.

    In: Journal of Monetary Economics, Vol. 56, No. 5, 07.2009, p. 639-652.

    Research output: Contribution to journalArticle

    Allen, Franklin ; Carletti, Elena ; Gale, Douglas. / Interbank market liquidity and central bank intervention. In: Journal of Monetary Economics. 2009 ; Vol. 56, No. 5. pp. 639-652.
    @article{dcde4f213bf54b4abab80e18c06f65fb,
    title = "Interbank market liquidity and central bank intervention",
    abstract = "We develop a simple model of the interbank market where banks trade a long term, safe asset. When there is a lack of opportunities for banks to hedge idiosyncratic and aggregate liquidity shocks, the interbank market is characterized by excessive price volatility. In such a situation, a central bank can implement the constrained efficient allocation by using open market operations to fix the short term interest rate. It can be constrained efficient for banks to hoard liquidity and stop trading with each other if there is sufficient uncertainty about aggregate liquidity demand compared to idiosyncratic liquidity demand.",
    keywords = "Constrained efficiency, Open market operations",
    author = "Franklin Allen and Elena Carletti and Douglas Gale",
    year = "2009",
    month = "7",
    doi = "10.1016/j.jmoneco.2009.04.003",
    language = "English (US)",
    volume = "56",
    pages = "639--652",
    journal = "Journal of Monetary Economics",
    issn = "0304-3932",
    publisher = "Elsevier",
    number = "5",

    }

    TY - JOUR

    T1 - Interbank market liquidity and central bank intervention

    AU - Allen, Franklin

    AU - Carletti, Elena

    AU - Gale, Douglas

    PY - 2009/7

    Y1 - 2009/7

    N2 - We develop a simple model of the interbank market where banks trade a long term, safe asset. When there is a lack of opportunities for banks to hedge idiosyncratic and aggregate liquidity shocks, the interbank market is characterized by excessive price volatility. In such a situation, a central bank can implement the constrained efficient allocation by using open market operations to fix the short term interest rate. It can be constrained efficient for banks to hoard liquidity and stop trading with each other if there is sufficient uncertainty about aggregate liquidity demand compared to idiosyncratic liquidity demand.

    AB - We develop a simple model of the interbank market where banks trade a long term, safe asset. When there is a lack of opportunities for banks to hedge idiosyncratic and aggregate liquidity shocks, the interbank market is characterized by excessive price volatility. In such a situation, a central bank can implement the constrained efficient allocation by using open market operations to fix the short term interest rate. It can be constrained efficient for banks to hoard liquidity and stop trading with each other if there is sufficient uncertainty about aggregate liquidity demand compared to idiosyncratic liquidity demand.

    KW - Constrained efficiency

    KW - Open market operations

    UR - http://www.scopus.com/inward/record.url?scp=68049107358&partnerID=8YFLogxK

    UR - http://www.scopus.com/inward/citedby.url?scp=68049107358&partnerID=8YFLogxK

    U2 - 10.1016/j.jmoneco.2009.04.003

    DO - 10.1016/j.jmoneco.2009.04.003

    M3 - Article

    VL - 56

    SP - 639

    EP - 652

    JO - Journal of Monetary Economics

    JF - Journal of Monetary Economics

    SN - 0304-3932

    IS - 5

    ER -