Optimal liquidity policy with shadow banking Academic Article

abstract

• 2018, Springer-Verlag GmbH Germany, part of Springer Nature. We study the impact of shadow banking on optimal liquidity regulation in a DiamondDybvig maturity-mismatch environment. In this economy, a pecuniary externality arising out of the banks access to private retrade renders competitive equilibrium inefficient. A tax on illiquid assets and a subsidy to the liquid asset similar to the payment of interest on reserves (IOR) constitute an optimal liquidity regulation policy. Shadow banking gives banks an outside option allowing them to escape regulation at the cost of forgoing access to the government safety net. We derive two implications of shadow banking for optimal liquidity regulation policy. First, optimal policy must implement a macroprudential cap on illiquid-asset prices that binds only when the return on illiquid assets is high. Second, optimal policy must implement a fire sale of illiquid assets when high demand for liquidity is anticipated. We show how these features can be implemented by adjusting the IOR rate and the illiquid-asset tax rate.

authors

• Zhang, Yuzhe

published proceedings

• ECONOMIC THEORY

author list (cited authors)

• Grochulski, B., & Zhang, Y.

citation count

• 9

complete list of authors

• Grochulski, Borys||Zhang, Yuzhe

publication date

• November 2019

publisher

• Springer Nature  Publisher

published in

• Economic Theory  Journal

keywords

• Illiquid-asset Tax
• Interest On Reserves
• Liquidity Regulation
• MECHANISM DESIGN
• Maturity Mismatch
• Pecuniary Externality
• Private Retrade
• Shadow Banking

Digital Object Identifier (DOI)

• 10.1007/s00199-018-1152-6

start page

• 967

end page

• 1015

volume

• 68

issue

• 4

URL

• http://dx.doi.org/10.1007/s00199-018-1152-6