Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/250325
Year of Publication: 
2020
Series/Report no.: 
Cardiff Economics Working Papers No. E2020/15
Publisher: 
Cardiff University, Cardiff Business School, Cardiff
Abstract: 
This paper identifies a precautionary banking liquidity shock via a set of sign, zero and forecast variance restrictions imposed. The shock proxies the reluctance of the banking sector to "lend" to the real economy induced by an exogenous change in financial intermediaries' preference for "high" liquid assets. The identified shock has sizeable and state (volatility) dependent effects on the real economy. To understand the transmission of the shock, we develop a DSGE model of financial intermediation with credit and liquidity frictions. The precautionary liquidity shock is shown to work through two channels: it increases the level of reserves and the deposit rate. The former is a balance sheet effect, which reduces the loan-to-deposit ratio. The higher deposit rate affects the intertemporal decisions of households and the cost of borrowing to firms. The overall effect is a downward co-movement in output, consumption, investment and prices, which is amplified the higher are the long-run risks in the economy and the responsiveness of banks to potential risk.
Subjects: 
SVAR
Sign and Zero Restrictions
DSGE
Precautionary Liquidity Shock
Excess Reserves
Deposit Rate
Risk
Financial Intermediation
JEL: 
C10
C32
E30
E43
E51
G21
Document Type: 
Working Paper

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