Abstract
This thesis studies the role of the banking system in several aspects
of the macroeconomy, including the likelihood of financial
crises, volatility of asset prices and the transmission of monetary
policy.
In chapter 2, I analyze the accumulation of international reserves by
central banks as insurance against financial crises. In the
model, private banks borrow from foreign creditors to invest in domestic
projects. By lending to banks in response to liquidity
shocks, the central bank can reduce the liquidation of bank assets and
lower the probability of bank runs. I show that the
central bank will hold more reserves when private banks hold lower
reserves. I also find that if the central bank can borrow
additional loans from external sources, then domestic banks will hold
fewer reserves by themselves. If the borrowing cost of
external loan is very high, then the central bank may actually want to
accumulate more reserves in order to avoid borrowing from
external sources at high costs.
In chapter 3, I show that the ability of banks to supply liquidity
through money creation is important for financial stability.
By supplying liquidity, banks can smooth the sale of assets and
stabilize asset prices. I find that without elastic money, the
attempt of non-bank mutual funds to raise cash by selling assets will
only add more volatility into the market. Elastic money
provided by banks can help mutual funds better smooth the consumption
of their shareholders.
In chapter 4, we consider the role of elastic money in an different
environment where liquidity shocks affect agents
asymmetrically. We show how money growth and interest rate policy can be
used to adjust the consumption level of households. We
find that the optimal policy is affected by the sensitivity of the
supply price to the interest rate. When the supply price is
more sensitive to the interest rate, it would be better to adopt a
higher inflation rate, and to make the zero-bound of nominal
interest rate less likely to be binding.
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