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Identifying a Liquidity Effect in the Japanese Interbank Market
Author(s) -
Hayashi Fumio
Publication year - 2001
Publication title -
international economic review
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 2.658
H-Index - 86
eISSN - 1468-2354
pISSN - 0020-6598
DOI - 10.1111/1468-2354.00111
Subject(s) - interbank lending market , market liquidity , monetary economics , open market operation , liquidity crisis , overnight rate , economics , accounting liquidity , reserve requirement , liquidity risk , liquidity premium , statutory liquidity ratio , money market , overdraft , business , central bank , monetary policy , finance
This article examines whether there was a liquidity effect in the Japanese interbank market for reserves during the period from January 4, 1996, to February 12, 1999. According to the standard martingale model, the only determinant of the overnight rate during the reserve maintenance period is the rate that is expected to prevail on the settlement day (the last day of the period), but this model ignores the fact that reserves are used for interbank payments. If overdraft costs are introduced into banks' reserve management problem, the overnight rate will also depend on what this paper calls the reserve surplus, which captures the liquidity effect of reserves. We identify the liquidity effect by exploiting two institutional features. First, the overnight rates observed in the morning are forward rates for a contract to be settled later in the day. Second, changes in reserves that are due to factors other than open market operations are rendered temporary through defensive operations by the Open Market Desk. We show that the liquidity effect can be identified from the regression of the spot‐forward differential on these temporary liquidity shocks. Our estimates indicate that there was a liquidity effect, at least before the Yamaichi debacle of November 1997.