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FIIT-2: Monetary Policy and Financial Regulation
Credit Expansion and Credit Misallocation
1University of British Columbia; 2Hong Kong University of Science and Technology
This paper studies the effectiveness of market-based monetary policy in creating economic stimulus. We show that if the central bank injects too much liquidity into a two-sector economy, overheating can build up in the sector with lower financing friction, crowding out the demand for liquidity in the sector with higher friction. The crowding-out occurs in a self-reinforcing spiral because of feedback between the supply of liquidity and demand for liquidity. This limit to market-based monetary policy derives from misaligned lending incentives between the central bank and financial intermediaries. As a result, monetary policy, in relying on the credit market to allocate liquidity across the economy, could actually distort the credit market.
A Theory of Collateral for the Lender of Last Resort
1University of Amsterdam; 2Federal Reserve Bank of New York
We build a model to analyze the optimal lending and collateral policy for the lender of last resort. Key to our theory is the idea that the central bank's policy can impose an externality on private markets. On the one and, while lending against high-quality collateral protects the central bank from potential losses, it can adversely affect the pool of collateral in funding markets and thus impair their effcient functioning since the much needed high-quality collateral gets tied up with the central bank. On the other hand, while lending against low-quality collateral exposes the central bank to counterparty risk, it improves the pool of collateral in funding markets and can unlock frozen markets. We characterize the optimal policy for a central bank by taking account of these trade-offs. We show that, contrary to what is generally accepted, it may be optimal for the lender of last resort to lend against low-quality collateral.
Multinational Banks and Supranational Supervision
1University of Bologna, CEPR; 2HEC Paris; 3University of Vienna, CEPR
We study the supervision of multinational banks (MNBs), allowing for either national or supranational supervision. National supervision leads to insufficient monitoring of MNBs due to a coordination problem between supervisors. Supranational supervision may solve this problem and generate more monitoring. However, this increased monitoring can have unintended consequences, as it also affects the choice of foreign representation. Indeed, supranational supervision encourages MNBs to expand abroad using branches rather than subsidiaries. In some cases, it discourages foreign expansion altogether, so that financial integration paradoxically decreases.
More importantly, these changes completely neutralize the more intense monitoring that would otherwise occur with supranational supervision. Our paper provides insight into how the national boundaries of bank supervision interact with multinational banks.
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Conference: EFA 2017
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