Liquidity Risk and Monetary Policy

Stephan Sauer

Discussion Papers in Economics from University of Munich, Department of Economics

Abstract: This paper provides a framework to analyse emergency liquidity assistance of central banks on financial markets in response to aggregate and idiosyncratic liquidity shocks. The model combines the microeconomic view of liquidity as the ability to sell assets quickly and at low costs and the macroeconomic view of liquidity as a medium of exchange that influences the aggregate price level of goods. The central bank faces a trade-off between limiting the negative output effects of dramatic asset price declines and more inflation. Furthermore, the anticipation of central bank intervention causes a moral hazard effect with investors. This gives rise to the possibility of an optimal monetary policy under commitment.

Keywords: Liquidity shocks; Financial crises; Liquidity provision principle; Greenspan put; Optimal monetary policy intervention (search for similar items in EconPapers)
JEL-codes: E44 E58 G18 (search for similar items in EconPapers)
Date: 2007-08
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
References: View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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Persistent link: https://EconPapers.repec.org/RePEc:lmu:muenec:2012

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