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Market Con…dence and Liquidity Hoarding Volha Audzei Czech National Bank and CERGE-EI (Prague) May 2016 Motivation Credit crunch and central banks policy No agreement about the policy e¤ect in the literature: -Curdia and Woodford (2011) and Taylor and Williams (2009): was not e¢ cient or irrelevant -Del Negro et al. (2011) and Christensen et al. (2014), Gertler and Karadi (2011): helped avoid more severe recession Liquidity hoarding Change in sentiment Motivation Liquidity hoarding Motivation Impact on bank’s lending standards Motivation Paper contribution Counterparty risk in the interbank market Liquidity hoarding Policy exercises: liquidity provision, targeted liquidity provision, declining policy rate, relaxing collateral constraints Model Overview DSGE framework (Gertler and Karadi (2011)) Continuum of banks, indexed by i, lend to the real sector and to each other Two types of assets: safe (reserves), pays Rtres risky, pays Rtk+1 Banks di¤er by their beliefs about risky asset return, Êti Rtk+1 N (R̄tk ,KF , PtKF ) Model Overview Assumption 1: Rtk = α PKt Yt t + (1 Qt δ) Qt ζ t 1 Model Overview Assumption 1: Rtk = α PKt Yt t + (1 Qt δ) Qt ζ t 1 Assumption 2: ζ t = ρζ ζ t 1 + µt + εζ ,t (1) Model Overview Assumption 1: Rtk = α PKt Yt t + (1 Qt δ) Qt ζ t 1 Assumption 2: ζ t = ρζ ζ t 1 + µt + εζ ,t µt is a persistent shock µt = ρ µ µt 1 + vt (1) Model Overview Assumption 1: Rtk = α PKt Yt t + (1 Qt δ) Qt ζ t 1 Assumption 2: ζ t = ρζ ζ t 1 + µt + εζ ,t (1) µt is a persistent shock µt = ρ µ µt Experts’opinions 1 + vt µit = µt + θ it (2) Model Bank’s balance sheet Assets Manufacturers’claims Reserves Interbank lending Liabilities Deposits Interbank borrowing Net worth Model Bank’s problem Each bank maximizes expected return, choosing αit , hti : Model Bank’s problem Each bank maximizes expected return, choosing αit , hti : risky asset: αit Êti Rtk+1 Model Bank’s problem Each bank maximizes expected return, choosing αit , hti : risky asset: αit Êti Rtk+1 reserves: hti Rtres Model Bank’s problem Each bank maximizes expected return, choosing αit , hti : risky asset: αit Êti Rtk+1 reserves: hti Rtres interbank market lending: pti 1 αit hti Rtib Model Bank’s problem Each bank maximizes expected return, choosing αit , hti : risky asset: αit Êti Rtk+1 reserves: hti Rtres interbank market lending: pti 1 αit hti Rtib Êti Rtk+1 Rtib Lit or interbank market borrowing: Model Bank’s problem Each bank maximizes expected return, choosing αit , hti : risky asset: αit Êti Rtk+1 reserves: hti Rtres interbank market lending: pti 1 αit hti Rtib Êti Rtk+1 Rtib Lit or interbank market borrowing: Li interbank loan Lit = λb 0, for lenders (net worth), for borrowers Model Bank’s problem continued Collecting the terms by αit : αit Êti Rtk+1 pti Rtib αit = 1 for Êti Rtk+1 pti Rtib , αit = 0 for Êti Rtk+1 < pti Rtib Note: for each lender all borrowers are identical pti = Prob Êti Rtk+1 (1 + λb ) > Rt dt + λb Rtib A lender lends if pti Rtib > Rtres , hoards otherwise A borrower borrows if Êti Rtk+1 Rtib Model Interbank market and beliefs Model Crisis and policy responses "Fundamental" shock: ζ t = ρζ ζ t Sentiment shock: µ̂it = Policy: rpt = κ p Rtk+1 1 + µt + εζ ,t µt + η it Rt (Rk R) untargeted Qt Kt +1 + Rest = Dt + ψt (Qt Kt +1 + Rest ) targeted Qt Kt +1 + Rest = Dt + ψtarg Q t K t +1 t interest rate Rtres rpt collateral constraint λb rtλ Policy costs: τψt (Qt St + Rest ) or τψtarg (Qt St + Rest ) t Model Overview Results Impulse Responses to Sentiment (5%) and Fundamental Shock (5%) Eξ','ξ policy response hat premium 0 10 1 5 0.5 -2 -4 0 10 20 30 0 10 Y 20 30 10 C 0 0 0 -2 -2 -5 10 20 30 10 K 20 30 0 -10 20 30 20 30 20 30 Q 3 2 1 0 -1 10 10 L -5 30 -10 -4 -4 20 Res 0 -2 -4 -6 -8 10 N 20 30 20 30 10 R 0 0.2 0 -0.2 -0.4 -0.6 -10 -20 -30 10 20 GK basic 30 10 No expect.shock Expect.shock Pure expect.shock Results Role of the interbank market policy response prem 2 Y 0.2 0 0.1 0 -0.1 -0.2 0 -2 5 10 C 15 20 5 10 Res 15 20 5 10 K 15 20 5 10 R 15 20 5 10 15 share of borrowers 20 0 0 0 -0.1 -0.05 -0.2 -0.1 -0.4 5 10 L 15 20 5 10 N 15 20 0 0 0 -0.5 -0.2 -0.4 -0.2 -0.02 -1 5 10 Rres 15 20 0.05 5 10 15 interbank lending 20 0 0 -0.04 0 -2 -10 -4 -0.05 5 10 15 20 -20 Expect. shock 5 10 15 20 Pure expect. shock -6 5 10 No expect. shock 15 20 Results Policy e¤ects premium Y C Res -5 1.5 -2 -2 -4 -4 -10 1 0.5 -15 0 5 10 K 15 20 5 10 L 15 20 5 10 Q 15 20 0 -6 -8 -10 -12 -14 5 10 15 Rres 20 0.2 0 -0.2 -0.4 -0.6 0.2 0 -0.2 -0.4 5 10 15 Rib 20 -10 -4 -15 -20 5 10 15 20 policy response 15 20 untargeted 20 5 20 0.1 10 0.05 -4 10 5 10 15 policy costs 20 -2 5 5 10 15 20 interbank lending -2 -6 2 0 0.6 0.4 0.2 0 -0.2 5 10 15 20 share of borrowers 5 10 15 20 priv ate lev erage ratio 20 -20 -10 5 10 15 20 share of inv estors 15 -15 -5 -2 10 N -10 2 0 5 5 10 15 20 0 5 10 15 20 0 targeted 10 15 Results Policy e¤ects continued premium Y 3 -2 2 -4 1 -6 0 -8 5 10 K 15 20 -5 C -4 -6 5 10 L 15 20 4 2 0 -2 -4 -6 -10 -15 5 10 R 15 20 Res -5 -10 -15 -20 -25 -2 5 10 Q 15 20 0 -10 -5 -10 -20 5 10 15 20 share of inv estors 5 10 15 20 share of borrowers -10 -1 -1 -20 20 5 10 15 20 priv ate lev erage ratio 10 4 0 5 10 15 20 policy response 10 15 20 no response 20 5 20 0.1 10 0.05 -5 5 5 10 15 policy costs 20 0 0 5 10 15 20 interbank lending -20 5 2 20 20 0 10 15 Rib 15 40 1 -0.5 5 10 N -30 -15 0 0 5 5 10 collateral 15 20 0 untargeted 5 10 15 20 targeted 0 10 interest rate 15 Conclusion Investors’expectations generate long and large responses in model variables Banks hoard some liquidity provided by central bank due to their low sentiment Liquidity provision mitigates crisis slightly, but does not stop it, nor decreases its duration Future Work ? Motivation Investor Sentiment