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This paper shows how interbank market fragmentation disrupts the transmission of monetary policy. Fragmentation is the fact that banks, depending on their country of location, have different probabilities of default on their interbank borrowings. Once fragmentation is introduced into standard theoretical models of monetary policy implementation, excess liquidity arises endogenously. This leads short‐term interest rates to depart from the central bank policy rates. Using data on monetary policy operations, I show that this mechanism has been at work in the euro area since 2008. The model is used to analyze conventional and unconventional monetary policy measures.

This paper explores what history can tell us about the interactions between macroprudential and monetary policy. Based on numerous historical documents, we show that liquidity ratios similar to the Liquidity Coverage Ratio (LCR) were commonly used as monetary policy tools by central banks between the 1930s and 1980s. We build a model that rationalizes the mechanisms described by contemporary central bankers, in which an increase in the liquidity ratio has contractionary effects, because it reduces the quantity of assets banks can pledge as collateral. This effect, akin to quantity rationing, is more pronounced when excess reserves are scarce.

Some Euro area money market rates have been standing below the deposit facility rate since 2015, which coincided with the start of the Eurosystem’s public sector purchase program (PSPP). In this paper, we explore empirically the interactions between the PSPP and short term secured money market rates (repo rates). We document different channels through which asset purchases may affect the various segments of the Euro area repo market. Using proprietary data from the PSPP purchases and transactions made on the repo market for specific securities (“special”), our results show that the PSPP has contributed to push down repo rate, in particular prior to January 2017. On average, purchasing 1% of a bond outstanding is associated with a decline in its repo rate of -0.78 bps.

This paper shows how interbank market fragmentation disrupts monetary policy implementation. Fragmentation is defined as the situation where some banks are cut from the interbank loan market. The paper incorporates fragmentation in an otherwise standard theoretical model of monetary policy implementation, where profit maximizing banks, subject to reserve requirements, borrow and deposit funds at a central bank. It shows that in the presence of fragmentation, excess liquidity arises endogenously and the interbank rate declines below the central bank main rate. The interbank rate is then unstable. The paper documents that this is what happened in the Euro-Area since 2008. The model is also well suited to analyze unconventional monetary policy measures.