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Banks, Liquidity Management, and Monetary Policy
We develop a new framework to study the implementation of monetary policy through the banking system. Banks finance illiquid loans by issuing deposits. Deposit transfers across banks must be settled using central bank reserves. Transfers are random and therefore create liquidity risk, which in turn determines the supply of credit and the money multiplier. We study how different shocks to the banking system and monetary policy affect the economy by altering the trade-off between profiting from lending and incurring greater liquidity risk. We calibrate our model to study quantitatively why ...
Scrambling for Dollars: International Liquidity, Banks and Exchange Rates
We develop a theory of exchange rate fluctuations arising from financial institutions’ demand for dollar liquid assets. Financial flows are unpredictable and may leave banks “scrambling for dollars.” Because of settlement frictions in interbank markets, a precautionary demand for dollar reserves emerges and gives rise to an endogenous convenience yield on the dollar. We show that an increase in the dollar funding risk leads to a rise in the convenience yield and an appreciation of the dollar, as banks scramble for dollars. We present empirical evidence on the relationship between ...