Liquidity Requirements and Central Bank Interventions During Banking Crises

Abstract

This paper evaluates liquidity requirements and public liquidity injections in the context of financial crises, using a model that includes near-money assets. Some key effects are transmitted through liquidity premia and the price of liquid assets, producing a heterogeneous impact that depends on an agent’s holdings of liquid assets. In addition, some agents prefer policies that do not fully relax their liquidity constraints because these policies are associated with higher prices. Liquidity requirements and liquidity injections have the opposite impact on liquidity premia and combining them leads to Pareto improvements that cannot be achieved by each policy separately. This paper was accepted by Gustavo Manso, finance. Funding: This work was supported by the Wisconsin Alumni Research Foundation. Supplemental Material: The data files are available at https://doi.org/10.1287/mnsc.2023.4737 .