Unintended Consequences of Central Bank Lending in Financial Crises

Abstract I investigate the macroeconomic impact of central bank funding becoming a more attractive funding source to financial intermediaries in times of crisis. I show that the requirement to pledge collateral has a contractionary effect on private credit everything else equal, and thereby reduces the expansionary effect that such lending otherwise has. I use an estimated New-Keynesian model with financial frictions to show that the collateral effect explains the limited growth of Italian banks’ private credit in response to the ECB’s three-year LTROs. Finally, I explore whether changes in lending policy can offset the cumulative negative effects from the collateral effect.