Paper #1027

Title:

The role of interbank markets in monetary policy: A model with rationing

Authors:

Xavier Freixas and José Jorge

Date:

March 2007 (Revised: April 2008)

Abstract:

This paper analyses the impact of asymmetric information in the interbank market and establishes its crucial role in the microfoundations of the monetary policy transmission mechanism. We show that interbank market imperfections induce an equilibrium with rationing in the credit market. This has two major implications: first, it reconciles the irresponsiveness of business investment to the user cost of capital with the large impact of monetary policy (magnitude effect) and, second, it shows that banks’ liquidity positions condition their reaction to monetary policy (Kashyap and Stein liquidity effect).

Keywords:

Banking, Rationing, Monetary Policy

JEL codes:

E44, G21

Area of Research:

Finance and Accounting

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