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Liquidity, term spreads and monetary policy
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Basso, Henrique S. and Aksoy, Yunus (2011) Liquidity, term spreads and monetary policy. Working Paper. Coventry: Department of Economics, University of Warwick. (Unpublished)
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Abstract
We propose a model that delivers endogenous variations in term spreads driven primarily by banks’ portfolio decision and their appetite to bear the risk of maturity transformation. We show that fluctuations of the future profitability of banks’ portfolios affect their ability to cover for any liquidity shortage and hence influence the premium they require to carry maturity risk. During a boom, profitability is increasing and thus spreads are low, while during a recession profitability is decreasing and spreads are high, in accordance with the cyclical properties of term spreads in the data. We also present empirical evidence on the linkages between yield spreads and financial businesses’ expected profitability. Finally, we use the model to look at monetary policy and show that allowing banks to sell long-term assets to the central bank after a liquidity shock leads to a sharp decrease in long-term rates and term spreads. Furthermore, such interventions have significant impact on long-term investment, decreasing the amplitude of output responses after a liquidity shock. The short-term rate does not need to be decreased as much and inflation turns out to be much higher than if no QE interventions were implemented.
| Item Type: | Working or Discussion Paper (Working Paper) | ||||
|---|---|---|---|---|---|
| Subjects: | H Social Sciences > HB Economic Theory | ||||
| Divisions: | Faculty of Social Sciences > Economics | ||||
| Publisher: | Department of Economics, University of Warwick | ||||
| Place of Publication: | Coventry | ||||
| Official Date: | 28 November 2011 | ||||
| Dates: |
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| Number of Pages: | 44 | ||||
| Status: | Not Peer Reviewed | ||||
| Publication Status: | Unpublished | ||||
| Access rights to Published version: | Open Access (Creative Commons) |
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