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Does interbank market matter for business cycle fluctuation? An estimated DSGE model with financial frictions for the Euro area

Federico Giri

Economic Modelling, 2018, vol. 75, issue C, 10-22

Abstract: The aim of this paper is to assess the impact of an increase in the European interbank riskiness and its influence on the business cycle. In order to do that, we build an estimated DSGE model that includes an explicit interbank market. Our results show that an increase of interbank default risk can generate a money market freeze. The subsequent flight-to-quality diverts funds from the risky interbank to the safer government bonds market causing a reduction of the credit supply. In this scenario, the standard monetary policy is ineffective due to the decoupling of policy and credit interest rates. A supplementary monetary stimulus is able to reduce default risk and thus shifting financial intermediaries preferences towards interbank lending. Finally, the monetary authority is able to avoid the accumulation of safe assets, partially alleviating the liquidity shortage and, to a lesser extent, dampen the drop in the real activity.

Keywords: DSGE model; Safe asset hoarding; Interbank market; Default risk; Bayesian estimation; Monetary policy (search for similar items in EconPapers)
JEL-codes: E30 E44 E51 E52 (search for similar items in EconPapers)
Date: 2018
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