Liquidity Shortages and Monetary Policy

Gerhard Illing and Jin Cao ()

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

Abstract: The paper models the interaction between risk taking in the financial sector and central bank policy. It shows that in the absence of central bank intervention, the incentive of financial intermediaries to free ride on liquidity in good states may result in excessively low liquidity in bad states. In the prevailing mixed-strategy equilibrium, depositors are worse off than if banks would coordinate on more liquid investment. It is shown that public provision of liquidity improves the allocation, even though it encourages more risk taking (less liquid investment) by private banks.

Keywords: Liquidity Provision; Monetary Policy; Bank Runs (search for similar items in EconPapers)
JEL-codes: E5 G21 G28 (search for similar items in EconPapers)
Date: 2007-07
New Economics Papers: this item is included in nep-ban, nep-cba, nep-mac and nep-mon
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Citations: View citations in EconPapers (2)

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Related works:
Working Paper: Liquidity Shortages and Monetary Policy (2008)
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Persistent link: https://EconPapers.repec.org/RePEc:lmu:muenec:2008

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