Macroeconomic Stabilisation and Emergency Liquidity Assistance

Document downloaded from http://zl.elsevier.es, day 25/06/2014. This copy is for personal use. Any transmission of this document by any media or format is strictly prohibited. Ensayos sobre Política Económica 32 (73) (2014) 5-16 Ensayos sobre POLÍTICA ECONÓMICA www.elsevier.es/espe Macroeconomic Stabilisation and Emergency Liquidity Assistance Marcelo Sánchez European Central Bank, Frankfurt am Main, Germany ARTICLE INFO ABSTRACT History of the article: Received June 19, 2013 Accepted October 25, 2013 We introduce imperfect monetary policy transparency and strategic wage setting into a macro model where the central bank provides lender of last resort (LOLR) services to banks on top of its standard stabilisation policy. We study how, in the presence of adverse exogenous financial developments, macroeoconomic and financial instability can be dampened by adjustments in policy institutions and economic structure. In a context of costly LOLR transactions and no moral hazard, the central bank has an incentive to save only large banks. Central bank opaqueness can help improve macroeconomic and financial stability by making wages closer to their competitive levels. Some results depend on initial conditions concerning monetary institutions; for instance, monetary strictness and wage bargaining centralisation help discipline wages and thus are stability-enhancing when central bank policies are initially seen as rather strict and transparent. Some consideration is given to the roles of trade openness and moral hazard behaviour on the part of banks. © 2013 Banco de la República de Colombia. Published by Elsevier España, S.L. All rights reserved. Jel Classification: E50 E52 E58 G21 G28 J51 Keywords: Macroeconomic stabilisation Lender of last resort Banking crises Monetary accommodation Central bank transparency Wage bargaining Clasificación JEL: E50 E52 E58 G21 G28 J51 Palabras clave: La estabilización macroeconómica Prestamista de última instancia Las crisis bancarias Acomodación monetaria La transparencia del banco central La negociación salarial Estabilización macroeconómica y asistencia de liquidez de emergencia RESUMEN Introducimos imperfecciones en la transparencia de la política monetaria y fijación estratégica de salarios dentro de un modelo macro donde el banco central provee servicios de prestamista de última instancia (PUI) a bancos comerciales además de la habitual política de estabilización. Estudiamos cómo, en presencia de eventos financieros adversos de carácter exógeno, la inestabilidad macroeoconómica y financiera puede ser amortiguada a través de ajustes en las instituciones políticas y la estructura económica. En un contexto de transacciones de PUI costosas y ausencia de riesgo moral, el banco central tiene un incentivo a rescatar sólo bancos grandes. La opacidad del banco central puede ayudar a mejorar la estabilidad macroeoconómica y financiera al inducir los salarios a aproximarse a su novel competitivo. Algunos resultados dependen de las condiciones initiales relativas a las instituciones monetarias; por ejemplo, la restricción monetaria y la centralización en las negociaciones salariales ayudan a disciplinar los salarios y así a estabilizar la economía cuando la política monetaria es inicialmente pecibida como bastante estricta y transparente. Damos alguna consideración a los roles de la apertura comercial y al comportamiento de riesgo moral por parte de los bancos. © 2013 Banco de la República de Colombia. Publicado por Elsevier España, S.L. Todos los derechos reservados. 1. Introduction In numerous countries the main goal of monetary policy is to maintain price stability. To do so, the central bank (CB) follows a policy rule enjoying a substantial degree of independence. Suitably E-mail address: designed, monetary policy rules may deliver price stability as well as maintain output close to its potential. The ongoing worldwide financial crisis has made clear that, beyond price stability, financial stability (comprising the provision of CB liquidity and the use of prudential rules) is and remains an essential objective. In recent years, there has been a sizeable increase in the provision of lender of last resort (LOLR) services to individual commercial banks, whereby CBs stand ready to inject high-powered money into the banking system 1135-2523 © 2013 Banco de la República de Colombia. Publicado por Elsevier España, S.L. Todos los derechos reservados. Document downloaded from http://zl.elsevier.es, day 25/06/2014. This copy is for personal use. Any transmission of this document by any media or format is strictly prohibited. 6 M. Sánchez / Ensayos sobre Política Económica 32 (73) (2014): 5-16 whenever a bank is solvent but suffers from temporary liquidity problems.1 LOLR services to individual commercial banks have been a common practice, although in theory failures of banks could be prevented by implementing appropriate systems of bank regulation and supervision or private safety nets. These instruments are thus deemed insufficient to prevent CBs from intervening in the banking sector. Despite the relevance of financial stability considerations, the economics profession does not offer a workhorse model for how macroprudential actions interact with the more traditional inflation-fighting role of monetary policy. It has been emphasised that, in the present context, multiple objectives require multiple instruments (Blanchard et al., 2012). But a better understanding is needed of issues such as what instruments should monetary and other authorities use to achieve these macroprudential goals, how large are the relevant trade-offs between macroeconomic performance and financial stability, and how economic uncertainty affects the conduct of CB policies.2 It has been argued that the CB should provide liquidity to the market and should not lend to individual banks, which would be able to borrow in the interbank market if they are considered to be solvent (Goodfriend and King, 1988). This view, however, assumes that interbank markets work perfectly and that the market is as well or better informed than the CB about the relative solvency of a bank short of liquidity. Moreover, LOLR transactions could obey to a macro rather than a micro motivation. Four valuable formal approaches have deviated from such view and contributed to understanding why CBs provide LOLR services: credit frictions, financial innovation, and learning. 5 In the decentralised equilibrium each household fails to internalise the effect of its borrowing decisions on asset prices, leading to excessive debt accumulation and too frequent crises. When the CB has better information than banks about the economic outlook, macroprudential policy would be justified since it can help offset the pecuniary externality generated by the collateral constraint. • Third, Goodhart and Huang (2005) assess the role of both contagious risks and moral hazard at the macro-level. If an illiquid, but sol (...truncated)