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Implementing Monetary Policy in a Fragmented Monetary Union

Miklos Vari ()

No 1516, CEPREMAP Working Papers (Docweb) from CEPREMAP

Abstract: This paper shows how interbank market fragmentation disrupts monetary policy implementation. Fragmentation is defined as the situation where some banks are cut from the interbank loan market. The paper introduces fragmentation into an otherwise standard theoretical model of monetary policy implementation, where profit maximizing banks, subject to reserve requirements, borrow and deposit funds at the central bank. In the presence of fragmentation, excess liquidity arises endogenously and the interbank rate declines below the central bank main rate. The interbank rate is then unstable. Using data on cross-border financial flows and monetary policy operations, this paper shows that this mechanism has been at work in the euro area since 2008. The model is suitable to analyze conventional and unconventional monetary policy measures in the euro area as well as in other currency areas.

Keywords: Fragmentation; Excess liquidity; interbank market; TARGET2 imbalances (search for similar items in EconPapers)
Pages: 48 pages
Date: 2015-08
New Economics Papers: this item is included in nep-cba, nep-eec and nep-mon
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Working Paper: Implementing monetary policy in a fragmented monetary union (2014) Downloads
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