Central bank interventions and asset market liquidity

Athanasios Geromichalos, Kuk Mo Jung, Ioannis Kospentaris, Changhyun Lee and Sukjoon Lee
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Sukjoon Lee: Department of Economics, University of California Davis

No 373, Working Papers from University of California, Davis, Department of Economics

Abstract: Central banks around the world routinely engage in asset purchases in secondary markets as part of implementing monetary policy or enhancing market liquidity, but the effects of such interventions are not yet fully understood. We develop a multi-asset general equilibrium model in which the liquidity of an asset is endogenous and depends on the terms of trade in each asset's respective secondary market, which are, in turn, driven by agents' market entry decisions and the possibility of central bank intervention. We use our model to qualitatively and quantitatively rationalize the superior liquidity of U.S. Treasuries over corporate bonds of comparable safety. Our model highlights and quantifies an unexplored link between fiscal and monetary policy: central bank interventions in the market for Treasuries increase secondary market liquidity for these securities, thus indirectly aiding the Treasury to borrow at lower rates. Our results also reveal that central bank interventions can have spillover effects on markets where the bank does not participate, offering a cautionary note to both policymakers and empirical researchers.

Keywords: monetary-search models; OTC markets; liquidity; central bank asset purchases (search for similar items in EconPapers)
JEL-codes: E31 E43 E52 G12 (search for similar items in EconPapers)
Pages: 42
Date: 2025-08-16
New Economics Papers: this item is included in nep-dge and nep-mon
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