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Unconventional monetary policy and funding liquidity risk

Author

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  • d'Avernas, Adrien
  • Vandeweyer, Quentin
  • Darracq Pariès, Matthieu

Abstract

This paper investigates the efficiency of various monetary policy instruments to stabilize asset prices in a liquidity crisis. We propose a macro-finance model featuring both traditional and shadow banks subject to funding risk. When banks are well capitalized, they have access to money markets and efficiently mitigate funding shocks. When aggregate bank capital is low, a vicious cycle arises between declining asset prices and funding risks. The central bank can partially counter these dynamics. Increasing the supply of reserves reduces liquidity risk in the traditional banking sector, but fails to reach the shadow banking sector. When the shadow banking sector is large, as in the US in 2008, the central bank can further stabilize asset prices by directly purchasing illiquid securities. JEL Classification: E43, E44, E52, G12

Suggested Citation

  • d'Avernas, Adrien & Vandeweyer, Quentin & Darracq Pariès, Matthieu, 2020. "Unconventional monetary policy and funding liquidity risk," Working Paper Series 2350, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:20202350
    Note: 3107481
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    File URL: https://www.ecb.europa.eu//pub/pdf/scpwps/ecb.wp2350~32855510af.en.pdf
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    Cited by:

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    2. Laeven, Luc & Maddaloni, Angela & Mendicino, Caterina, 2022. "Monetary policy, macroprudential policy and financial stability," Working Paper Series 2647, European Central Bank.
    3. policy, Work stream on macroprudential & Albertazzi, Ugo & Martin, Alberto & Assouan, Emmanuelle & Tristani, Oreste & Galati, Gabriele & Vlassopoulos, Thomas, 2021. "The role of financial stability considerations in monetary policy and the interaction with macroprudential policy in the euro area," Occasional Paper Series 272, European Central Bank.
    4. Franklin Allen & Xian Gu, 2021. "Shadow banking in China compared to other countries," Manchester School, University of Manchester, vol. 89(5), pages 407-419, September.
    5. Cimon, David A. & Walton, Adrian, 2024. "Central bank liquidity facilities and market making," Journal of Banking & Finance, Elsevier, vol. 162(C).

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    More about this item

    Keywords

    asset pricing; money markets; quantitative easing; shadow banks;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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