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American Economic Journal: Macroeconomics: Vol. 4 No. 2 (April 2012)

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Imperfect Competition in the Interbank Market for Liquidity as a Rationale for Central Banking

Article Citation

Acharya, Viral V., Denis Gromb, and Tanju Yorulmazer. 2012. "Imperfect Competition in the Interbank Market for Liquidity as a Rationale for Central Banking." American Economic Journal: Macroeconomics, 4(2): 184-217.

DOI: 10.1257/mac.4.2.184

Abstract

We study interbank lending and asset sales markets in which banks with surplus liquidity have market power vis-à-vis banks needing liquidity, frictions arise in lending due to moral hazard, and assets are bank-specific. Surplus banks ration lending and instead purchase assets from needy banks, an inefficiency more acute during financial crises. A central bank acting as a lender-of-last-resort can ameliorate this inefficiency provided it is prepared to extend potentially loss-making loans or is better informed than outside markets, as might be the case if it also performs a supervisory role. This rationale for central banking finds support in historical episodes. (JEL E58, G01, G21, G28, L13, N21)

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Authors

Acharya, Viral V. (NYU)
Gromb, Denis (INSEAD, Fontainebleau)
Yorulmazer, Tanju (Federal Reserve Bank of New York)

JEL Classifications

E58: Central Banks and Their Policies
G01: Financial Crises
G21: Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
G28: Financial Institutions and Services: Government Policy and Regulation
L13: Oligopoly and Other Imperfect Markets
N21: Economic History: Financial Markets and Institutions: U.S.; Canada: Pre-1913

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