Interbank market liquidity and central bank intervention

Franklin Allen, Elena Carletti, Douglas Gale

    Research output: Contribution to journalArticle

    Abstract

    We develop a simple model of the interbank market where banks trade a long term, safe asset. When there is a lack of opportunities for banks to hedge idiosyncratic and aggregate liquidity shocks, the interbank market is characterized by excessive price volatility. In such a situation, a central bank can implement the constrained efficient allocation by using open market operations to fix the short term interest rate. It can be constrained efficient for banks to hoard liquidity and stop trading with each other if there is sufficient uncertainty about aggregate liquidity demand compared to idiosyncratic liquidity demand.

    Original languageEnglish (US)
    Pages (from-to)639-652
    Number of pages14
    JournalJournal of Monetary Economics
    Volume56
    Issue number5
    DOIs
    StatePublished - Jul 2009

    Keywords

    • Constrained efficiency
    • Open market operations

    ASJC Scopus subject areas

    • Finance
    • Economics and Econometrics

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