The short rate disconnect in a monetary economy

Moritz Lenel, Monika Piazzesi and Martin Schneider

Journal of Monetary Economics, 2019, vol. 106, issue C, 59-77

Abstract: In modern monetary economies, most payments are made with inside money provided by payment intermediaries. This paper studies interest rate dynamics when payment intermediaries value short bonds as collateral to back inside money. We estimate intermediary Euler equations that relate the short safe rate to other interest rates as well as intermediary leverage and portfolio risk. Towards the end of economic booms, the short rate set by the central bank disconnects from other interest rates: as collateral becomes scarce and spreads widen, payment intermediaries reduce leverage, and increase portfolio risk. We document stable business cycle relationships between spreads, leverage, and the safe portfolio share of payment intermediaries that are consistent with the model. Structural changes, especially in regulation, induce low frequency shifts, such as after the financial crisis.

Keywords: Monetary policy; Bank leverage; Cost of safety (search for similar items in EconPapers)
JEL-codes: E40 E43 G21 (search for similar items in EconPapers)
Date: 2019
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Citations: View citations in EconPapers (12)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:moneco:v:106:y:2019:i:c:p:59-77

DOI: 10.1016/j.jmoneco.2019.07.008

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