Asset Prices and Standing Facilities in a Monetary Economy

Abstract

This paper develops a general equilibrium model of money and banking in which the central bank opens a discount window and pays an interest rate on reserves. With aggregate uncertainty, banks exhaust their monetary reserves and access to the discount window in some states of nature. Changing the interest-rate corridor, defined as the difference between the discount and the deposit rates, generates responses in the bank's portfolio choice, asset prices, welfare, and the liquidity structure of assets' yields. The discount window policy can be a potential source of both the indeterminacy of equilibria and instability of asset prices.