Inefficient Liquidity Creation

49 Pages Posted: 7 Feb 2018 Last revised: 16 Jun 2021

See all articles by Stephan Luck

Stephan Luck

Federal Reserve Bank of New York

Paul Schempp

University of Cologne - Center for Macroeconomic Research (CMR); Max Planck Institute for Research on Collective Goods

Date Written: April 4, 2019

Abstract

We present a model in which intermediaries create liquidity by issuing safe debt. Two types of intermediaries emerge: Traditional banks that create liquidity by issuing equity and holding assets to maturity, and market-based intermediaries that create liquidity by selling assets in fire sales in downturns. We show that the reliance on market-based intermediation is necessarily too high, but liquidity creation is not. It can also be too low as the endogenous fire-sale risk can push liquidity creation below its optimum. We argue that standard capital or liquidity regulation are ineffective, and optimal macroprudential regulation should instead target market-based intermediation.

Keywords: banking; macroprudential regulation; liquidity creation; fire sales; pecuniary externalities; shadow banking; regulatory arbitrage

JEL Classification: G01, G21, G23, G28

Suggested Citation

Luck, Stephan and Schempp, Paul, Inefficient Liquidity Creation (April 4, 2019). Available at SSRN: https://ssrn.com/abstract=3113000 or http://dx.doi.org/10.2139/ssrn.3113000

Stephan Luck (Contact Author)

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

Paul Schempp

University of Cologne - Center for Macroeconomic Research (CMR) ( email )

Cologne
Germany

Max Planck Institute for Research on Collective Goods ( email )

Kurt-Schumacher-Str. 10
D-53113 Bonn, 53113
Germany

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
193
Abstract Views
1,468
rank
212,914
PlumX Metrics