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Monetary Policy and Bank Liquidity Creation: A Multivariate Markov Switching Approach

Author

Listed:
  • Mustafa Caglayan

    (Edinburgh Business School, Heriot–Watt University, UK)

  • Kostas Mouratidis

    (Department of Economics, University of Sheffield, UK)

Abstract
Despite its importance, there is little empirical research on how monetary policy affects bank-liquidity creation. We propose a general Markov switching framework to examine the effects of monetary policy on liquidity creation while accounting for endogenous regime switches and capturing the idea that financial crises could be due to a regime switch from information-insensitive debt to information-sensitive debt. Using total liquidity creation and its components for different bank-size categories, we show that monetary policy has a regime dependent impact. Furthermore, based on the filter probabilities, our analysis also raises the possibility of a future financial turmoil.

Suggested Citation

  • Mustafa Caglayan & Kostas Mouratidis, 2022. "Monetary Policy and Bank Liquidity Creation: A Multivariate Markov Switching Approach," Working Papers 2022003, The University of Sheffield, Department of Economics.
    • Handle: RePEc:shf:wpaper:2022003
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    File URL: https://www.sheffield.ac.uk/economics/research/serps
    File Function: First version, March 2022
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    More about this item

    Keywords

    Liquidity creation; bank size; monetary policy; policy trade-off; asymmetric effects; Markov switching;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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