2024-11-0920211572-309710.1093/rof/rfab0022-s2.0-85107743887http://dx.doi.org/10.1093/rof/rfab002https://hdl.handle.net/20.500.14288/10255We consider a macroprudential approach to analyze the optimal lending policy for the central bank, focusing on spillover effects that policy exerts on money markets. Lending against high-quality collateral protects central banks against losses, but can adversely affect liquidity creation in markets since high-quality collateral gets locked up with the central bank rather than circulating in markets. Lending against low-quality collateral creates counterparty risk but can improve liquidity in markets. We illustrate the optimal policy incorporating these trade-offs. Contrary to what is generally accepted, lending against high-quality collateral can have negative effects, whereas it may be optimal to lend against low-quality collateral.Business enterprisesFinanceEconomicsJournal Article1573-692X685219800002Q19757