Bank Liquidity and Bubbles: Why Central Banks Should Lean Against Liquidity

Naqvi, Hassan; Acharya, Viral V.

Bank Liquidity and Bubbles: Why Central Banks Should Lean Against Liquidity

NEW PERSPECTIVES ON ASSET PRICE BUBBLES: THEORY, EVIDENCE, AND POLICY, Douglas Evanoff, George Kaufman, and A. G. Malliaris, eds., Oxford University Press, 2012

16 Pages Posted: 21 Mar 2012

See all articles by Hassan Naqvi

New York University (NYU) - Leonard N. Stern School of Business; New York University (NYU) - Department of Finance; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); National Bureau of Economic Research (NBER)

Date Written: January 1, 2012

Abstract

When liquidity chasing banks is high, loan officers (or risk-takers) inside banks expect future losses to be readily rolled over. This insurance effect induces them to relax lending standards. The resulting access to cheap credit can fuel asset price bubbles in the economy. To curb such risk-taking incentives at banks and the resulting asset bubbles, Central Banks should "lean against bank liquidity." In particular, Central Banks should adopt a contractionary monetary policy in times of excessive bank liquidity.

Keywords: Bubbles, Greenspan put, leaning against the wind, monetary policy, moral hazard

JEL Classification: E32, E52, E58, G21

Suggested Citation: Suggested Citation

Naqvi, Hassan and Acharya, Viral V. and Acharya, Viral V., Bank Liquidity and Bubbles: Why Central Banks Should Lean Against Liquidity (January 1, 2012). NEW PERSPECTIVES ON ASSET PRICE BUBBLES: THEORY, EVIDENCE, AND POLICY, Douglas Evanoff, George Kaufman, and A. G. Malliaris, eds., Oxford University Press, 2012, Available at SSRN: https://ssrn.com/abstract=2026550