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Monetary Policy, Excess Reserves and Credit Supply: Old-Style vs. New-Style Central Banking

Abstract: The operational framework in the U.S. changed from a corridor to a floor system in 2008 as a consequence of unconventional policies implemented to mitigate the Great Financial Crisis. In this paper I examine the effects of this switch on the transmission mechanism of conventional monetary policy. Concretely, I analyze if the bank-lending channel changed due to the alterations in the operational system. To this end, I first estimate a Hybrid-VAR model using U.S. data for both the pre-switch and post-switch sample. In the sample prior to the operational framework switch the bank-lending channel is shown to be active. However, in the post-switch sample, bank loans increase after a policy tightening shock. Additionally, I develop a regime-switching two-agent New Keynesian (TANK) model with an interbank market to compare the transmission mechanism of conventional policy across both systems. In line with the estimates, I find that under the old-style corridor system real activity declines after a monetary contraction. However, I show that under a new-style floor system, monetary tightening stimulates credit supply, due to the presence of a friction introduced by banks’ liquidity management costs.

Keywords: TANK; Monetary Transmission Mechanism; Interbank Market; Liquidity Management

JEL Classification: E42, E44, E51, E52

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