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Bank Intermediation and Persistent Liquidity Effects in the Presence of a Frictionless Bond Market

Author

Listed:
  • Tor Einarsson
  • Milton H. Marquis
Abstract
An "expansionary" monetary policy that increases the growth rate of bank reserves is generally believed by policymakers to induce a "liquidity effect", or a persistent decline in short-term nominal interest rates, that stimulates real activity. Christiano, et al. (1991,1995,1997) have incorporated this feature of the economy into equilibrium business cycle models by introducing a commercial bank that acquires deposits from households and channels those funds to firms, which use them to fund their working capital expenses. Bank deposits are the only interest-bearing financial asset available to households, and bank loans are the only source of working capital finance available to firms. To obtain a liquidity effect in response to an unanticipated reserves injection, those models rely on an information friction whereby households precommit to a liquid asset position prior to the monetary shock. In practice, the capital markets are a major source of working capital finance, and U.S. data indicate that bank financing as a share of total short-term working capital finance is countercyclical.This paper extends this literature by introducing a bond market that allows for nonintermediated loans directly from households to firms, and examines the information friction that could induce liquidity effects and countercyclicality in the degree of bank intermediation of working capital finance. The results indicate that: (i) "sticky prices" are neither necessary nor sufficient to induce a liquidity effect; (ii) deposit precommitment by households along with a presetting of the deposit rate by banks does induce persistent liquidity effects, but results in excess volatility of consumption and investment; (iii) minimizing the deposit precommitment, while maintaining the preset deposit rate induces a weaker liquidity effect that is more in line with the data, without the excess volatility in consumption and investment; and (iv) the share of bank intermediation in working capital finance is countercyclical in all cases, including the absence of an information friction. ( JEL Classifications: E4,E5. Keywords: financial intermediation, liquidity, monetary policy. )

Suggested Citation

  • Tor Einarsson & Milton H. Marquis, 2003. "Bank Intermediation and Persistent Liquidity Effects in the Presence of a Frictionless Bond Market," Economics wp21_tor, Department of Economics, Central bank of Iceland.
    • Handle: RePEc:ice:wpaper:wp21_tor
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    References listed on IDEAS

    as
    1. Christiano, Lawrence J & Eichenbaum, Martin & Evans, Charles, 1996. "The Effects of Monetary Policy Shocks: Evidence from the Flow of Funds," The Review of Economics and Statistics, MIT Press, vol. 78(1), pages 16-34, February.
    2. Marvin Goodfriend & Robert G. King, 1997. "The New Neoclassical Synthesis and the Role of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 231-296, National Bureau of Economic Research, Inc.
    3. Christiano, Lawrence J. & Eichenbaum, Martin & Evans, Charles L., 1997. "Sticky price and limited participation models of money: A comparison," European Economic Review, Elsevier, vol. 41(6), pages 1201-1249, June.
    4. Lucas, Robert Jr., 1990. "Liquidity and interest rates," Journal of Economic Theory, Elsevier, vol. 50(2), pages 237-264, April.
    5. den Haan, Wouter J & Marcet, Albert, 1990. "Solving the Stochastic Growth Model by Parameterizing Expectations," Journal of Business & Economic Statistics, American Statistical Association, vol. 8(1), pages 31-34, January.
    6. Einarsson, Tor & Marquis, Milton H, 2001. "Bank Intermediation over the Business Cycle," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 33(4), pages 876-899, November.
    7. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 50(6), pages 1345-1370, November.
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    9. Fuerst, Timothy S., 1992. "Liquidity, loanable funds, and real activity," Journal of Monetary Economics, Elsevier, vol. 29(1), pages 3-24, February.
    10. repec:bla:jfinan:v:53:y:1998:i:3:p:845-878 is not listed on IDEAS
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    Cited by:

    1. Tor Einarsson & Milton H. Marquis, 2002. "Banks, bonds, and the liquidity effect," Economic Review, Federal Reserve Bank of San Francisco, pages 35-50.
    2. Richard K. Lyons, 2002. "Foreign exchange: macro puzzles, micro tools," Economic Review, Federal Reserve Bank of San Francisco, pages 51-69.

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    More about this item

    Keywords

    financial intermediation; liquidity; monetary policy. );
    All these keywords.

    JEL classification:

    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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