The Liquidity Premium Channel of Monetary Policy

This paper studies how exogenous liquidity shocks transmit from central bank balance-sheet operations to bank contract pricing. Using real-time liquidity forecasts from the Central Reserve Bank of Peru (BCRP), I identify reserve-supply shocks from forecast errors in the calibration of daily open market operations. The main analysis quantifies how these shocks affect financial conditions in the banking sector by estimating the dynamic response of lending and deposit spreads relative to safe yields of comparable maturity. I find that a positive liquidity shock to financial institutions generates a sizable and persistent compression of spreads, driven by declines in bank credit and deposit rates while safe yields respond little, consistent with a reduction in the liquidity premia embedded in bank contracts. The results are robust across alternative maturities, liquidity measures, model specifications, and alternative approaches to the measurement of liquidity shocks. These findings imply that balance-sheet and liquidity management policies can influence the effective stance of monetary policy not only through the level of short-term rates, but also through the pricing of liquidity risk that shapes bank spreads and borrowing costs.