This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. This paper examines the impact of macroeconomic and financial sector policy announcements during the recent crisis on interbank credit and liquidity risk premia. Announcements of interest rate cuts, liquidity support, liability guarantees, and recapitalization were associated with a reduction of interbank risk premia, albeit to a different degree during the subprime and global phases of the crisis. Decisions not to reduce interest rates and bail out individual banks in an ad hoc manner had adverse repercussions, both domestically and abroad. The results are robust to controlling for the surprise content of announcements and using alternative measures of

We analyze public interventions to alleviate debt overhang among private firms when the government has limited information and limited resources. We compare the efficiency of buying equity, purchasing assets, and providing debt guarantees. With symmetric information, all the interventions are equivalent. With asymmetric information between firms and the government, buying equity dominates the two other interventions. We also solve for the optimal public intervention and show how it can be implemented with preferred stock and warrants.

non-standard monetary policy measures and monetary developments by Domenico Giannone,

We study the trading dynamics in a distressed asset market with search frictions. When trading of a financial asset ceases due to an adverse selection problem, a large player can resurrect the market by buying up bad assets which involves assuming financial losses. The player can, however, delay the intervention: a mere announcement today of intervening at a later point in time can cause markets to function again. This announcement effect gives rise to a trade-off between the size and the timing of the intervention. The optimal intervention involves balancing the financial losses from the intervention and the social cost of illiquid markets. If the losses are small and a market is deemed important, it is optimal to ensure that the market functions continuously. In this case, there is a fixed cost associated with intervention delay, making it optimal to intervene as early as possible at the minimum size. As losses increase and the importance of the market declines, the intervention is optimally delayed and it can be optimal to rely on the announcement effect by increasing the size of the intervention. Furthermore, our finding highlights the importance of search friction in the formation of market distress, the determination of policy announcement effect, and the optimal design of intervention. The views expressed in this paper are not necessarily the views of the Bank of Canada. 1 1

the minimum liquidity deficit and the maturity structure of central banks’ open market operations lessons from the financial crisis

We study interventions to restore efficient lending and investment when financial markets fail because of adverse selection. We solve a design problem where the decision to participate in a program offered by the government can be a signal for private information. We characterize optimal mechanisms and analyze specific programs often used during banking crises. We show that programs attracting all banks dominate those attracting only troubled banks, and that simple guarantees for new debt issuances implement the optimal mechanism, while equity injections and asset buyback do not. We also discuss the consequences of moral hazard.

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In 2009 all ECB publications feature a motif taken from the €200 banknote. This paper can be downloaded without charge from

economieS,

interbank lending,