Strategic Effects of Liquidity Injections, Lender-of-Last Resort Facilities and Monetary Policy responses to Asset Prices
Coordinator: Prof. Dr. Frank Heinemann
Liquidity injections during crises and lender-of-last-resort facilities raise concerns of moral hazard on the side of financial intermediaries. Time inconsistency of first-best monetary policy raises the question, how second best policies can be implemented. In an international context, cross-country spillovers of liquidity provision also raise strategic considerations of distinct central banks who may behave as players in a non-cooperative game. In this project, we analyze the strategic effects of liquidity provision and monetary policy responses to asset prices under distinct regimes of macroprudential regulation. Thereby, we want to contribute to the design of a new architecture for monetary policy and macroprudential regulation aimed at a balanced stabilization of inflation, output and financial markets.
In particular, we will focus on three topics:
1. Cross-country spillovers of liquidity provisions during financial crises and the interaction of these spillovers with equity and liquidity requirements. Here, we analyze a two-stage game with two central banks who may inject liquidity in the commercial banking sector after a crisis.
2. Moral hazard effects arising from time inconsistency of monetary policy. They will be explored by laboratory experiments. Here, we are most interested in whether reputation, cheap talk, or transparency can substitute for a commitment device.
3. Monetary policy responses to asset prices and their effects within a dynamic stochastic general equilibrium (DSGE) framework. The model will introduce a banking sector threatened by inefficient liquidation in case of a crisis into a real business cycle model for analyzing solvency risk and equity requirements and into a monetary New Keynesian DSGE model for analyzing liquiditiy risk and regulation.
- Radde, S. (2014): Flight to Liquidity and the Great Recession
- Cui, W. and S. Radde (2014): Search-Based Endogenous Illiquidity and the Macroeconomy