DP9767 Safe Assets, Liquidity and Monetary Policy

Author(s): Pierpaolo Benigno, Salvatore Nisticò
Publication Date: December 2013
Keyword(s): liquidity crisis, unconventional policies, zero lower bound
JEL(s): E30, E40, E50
Programme Areas: International Macroeconomics, Financial Economics
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=9767

This paper studies monetary policy in models where multiple assets have different liquidity properties: safe and "pseudo-safe" assets coexist. A shock worsening the liquidity properties of the pseudo-safe assets raises interest-rate spreads and can cause a deep recession cum deflation. Expanding the central bank's balance sheet fills the shortage of safe assets and counteracts the recession. Lowering the interest rate on reserves insulates market interest rates from the liquidity shock and improves risk sharing between borrowers and savers.