Date of this Version
Journal of Monetary Economics
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.
© 2009. This manuscript version is made available under the CC-BY-NC-ND 4.0 license http://creativecommons.org/licenses/by-nc-nd/4.0/.
Allen, F., Carletti, E., & Gale, D. (2009). Interbank Market Liquidity and Central Bank Intervention. Journal of Monetary Economics, 56 (5), 639-652. http://dx.doi.org/10.1016/j.jmoneco.2009.04.003
Date Posted: 27 November 2017
This document has been peer reviewed.