The (Unintended?) Consequences of the Largest Liquidity Injection Ever

Matteo Crosignani, Miguel Faria-e-Castro and Luís Fonseca

No 2017-039, Working Papers from Federal Reserve Bank of St. Louis

Abstract: The design of lender-of-last-resort interventions can exacerbate the bank-sovereign nexus. During sovereign crises, central bank provision of long-term liquidity incentivizes banks to purchase high yield eligible collateral securities matching the maturity of the central bank loans. Using unique security level data, we find that the European Central Bank's 3-year Long-Term Refinancing Operation caused Portuguese banks to purchase short-term domestic government bonds, equivalent to 10.6% of amounts outstanding, and pledge them to obtain central bank liquidity. The steepening of Eurozone peripheral sovereign yield curves right after the policy announcement is consistent with the equilibrium effects of this "collateral trade."

Keywords: Lender of Last Resort; Bank-Sovereign Nexus; Collateral; Sovereign Debt; Eurozone Crisis (search for similar items in EconPapers)
JEL-codes: E58 G21 G28 H63 (search for similar items in EconPapers)
Date: 2017-11-01
New Economics Papers: this item is included in nep-ban, nep-cba, nep-cfn, nep-eec, nep-mac and nep-mon
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Citations: View citations in EconPapers (40)

Published in Journal of Monetary Economics

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Related works:
Journal Article: The (Unintended?) consequences of the largest liquidity injection ever (2020)
Working Paper: The (Unintended?) Consequences of the Largest Liquidity Injection Ever (2017)
Working Paper: The (Unintended?) Consequences of the Largest Liquidity Injection Ever (2016)
Working Paper: The (unintended?) consequences of the largest liquidity injection ever (2016)
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DOI: 10.20955/wp.2017.039

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