Strategic effects of liquidity injections, lender-of-last-resort facilities and monetary policy responses to asset prices.

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Monetary policy during and after crises and lender-of-last-resort facilities raise concerns of moral hazard on the side of financial intermediaries. Time inconsistency of first-best monetary policy raises the question, how second best policies can be implemented. The interaction of economic agents calls for a game-theoretic analysis of the relationship between macroeconomic variables and financial markets. During the first phase of this program, we concentrated on three topics: the interdependency between government guarantees for the banking sector and sovereign defaults, time inconsistency of monetary policy, and macroeconomic effects of endogenous liquidity within dynamic stochastic general equilibrium (DSGE) models.During the next phase of this project, we shift our attention to behavioural foundations of monetary policy. 1. Building up on our work on lender-of-last-resort facilities and guarantee schemes provided to the banking sector, we plan to analyse bank runs by laboratory experiments. We are most interested in finding optimal response schemes to liquidity shocks that stave off bank runs and in combinations of pre-announced response schemes and rules of liquidity and equity regulation that minimize the probability of banking crises. 2. Within the framework of dynamic stochastic general equilibrium (DSGE) models, we plan to analyse the effects of loss aversion on the pricing process and its consequences for conducting monetary policy in the aftermath of financial crises. The overarching goal of this project is to analyse the strategic effects of liquidity provision and monetary policy under distinct regimes of macroprudential regulation. Thereby, we want to contribute to the design of a new architecture for monetary policy and macroprudential regulation aimed at a balanced stabilization of inflation, output and financial markets.