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Board of Governors of the Federal Reserve System (US)
Finance and Economics Discussion Series
The (Unintended?) Consequences of the Largest Liquidity Injection Ever
Matteo Crosignani
Miguel Faria-e-Castro
Luis Fonseca
Abstract

We study the design of lender of last resort interventions and show that the provision of long-term liquidity incentivizes purchases of high-yield short-term securities by banks. Using a unique security-level data set, we find that the European Central Bank’s three-year Long-Term Refinancing Operation incentivized Portuguese banks to purchase short-term domestic government bonds that could be pledged to obtain central bank liquidity. This "collateral trade" effect is large, as banks purchased short-term bonds equivalent to 8.4% of amount outstanding. The resumption of public debt issuance is consistent with a strategic reaction of the debt agency to the observed yield curve steepening.


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Matteo Crosignani & Miguel Faria-e-Castro & Luis Fonseca, The (Unintended?) Consequences of the Largest Liquidity Injection Ever, Board of Governors of the Federal Reserve System (US), Finance and Economics Discussion Series 2017-011, Jan 2017.
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Keywords: Lender of Last Resort ; Sovereign Debt ; Unconventional Monetary Policy
DOI: 10.17016/FEDS.2017.011
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