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Central Bank Haircut Policy

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  • James Chapman, Jonathan Chiu, and Miguel Molico

Abstract

We present a model of central bank collateralized lending to study the optimal choice of the haircut policy. We show that a lending facility provides a bundle of two types of insurance: insurance against liquidity risk as well as insurance against downside risk of the collateral. Setting a haircut therefore involves balancing the trade-off between relaxing the liquidity constraints of agents on one hand, and increasing potential inflation risk and distorting the portfolio choices of agents on the other. We argue that the optimal haircut is higher when the central bank is unable to lend exclusively to agents who actually need liquidity. Finally, for an unexpected drop in the haircut, the central bank can be more aggressive than when setting a permanent level of the haircut.

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Bibliographic Info

Paper provided by Bank of Canada in its series Working Papers with number 10-23.

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Length: 44 pages
Date of creation: 2010
Date of revision:
Handle: RePEc:bca:bocawp:10-23

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Related research

Keywords: Payment; clearing; and settlement systems; Central bank research; Monetary policy implementation; Financial system regulation and policies; Financial services;

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References

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  1. Koeppl, Thorsten & Monnet, Cyril & Temzelides, Ted, 2008. "A dynamic model of settlement," Journal of Economic Theory, Elsevier, vol. 142(1), pages 233-246, September.
  2. Jeffrey M. Lacker, 1998. "Collateralized debt as the optimal contract," Working Paper 98-04, Federal Reserve Bank of Richmond.
  3. Bhattacharya, Joydeep & Haslag, Joseph & Martin, Antoine, 2007. "Why Does Overnight Liquidity Cost More Than Intraday Liquidity?," Staff General Research Papers 13096, Iowa State University, Department of Economics.
  4. Aleksander Berentsen & Cyril Monnet, 2007. "Monetary Policy in a Channel System," CESifo Working Paper Series 1929, CESifo Group Munich.
  5. Antoine Martin & Cyril Monnet, 2008. "Monetary policy implementation frameworks: a comparative analysis," Staff Reports 313, Federal Reserve Bank of New York.
  6. ANTOINE MARTIN & JAMES McANDREWS, 2010. "Should There Be Intraday Money Markets?," Contemporary Economic Policy, Western Economic Association International, vol. 28(1), pages 110-122, 01.
  7. Ricardo Lagos & Randall Wright, 2004. "A unified framework for monetary theory and policy analysis," Staff Report 346, Federal Reserve Bank of Minneapolis.
  8. Jeffrey Lacker, 2001. "Online Appendix to Collateralized Debt as the Optimal Contract," Technical Appendices lacker01, Review of Economic Dynamics.
  9. James T. E. Chapman & Antoine Martin, 2007. "Rediscounting under aggregate risk with moral hazard," Staff Reports 296, Federal Reserve Bank of New York.
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Cited by:
  1. Sever, Can, 2014. "Systemic Liquidity Crisis with Dynamic Haircuts," MPRA Paper 55602, University Library of Munich, Germany.
  2. Aleksander Berentsen & Alessandro Marchesiani & Christopher J. Waller, 2013. "Floor systems for implementing monetary policy: Some unpleasant fiscal arithmetic," ECON - Working Papers 121, Department of Economics - University of Zurich, revised Sep 2013.
  3. Bindseil, Ulrich & Jabłecki, Juliusz, 2013. "Central bank liquidity provision, risk-taking and economic efficiency," Working Paper Series 1542, European Central Bank.

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