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Optimal Allotment Policy in Central Bank Open Market Operations

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Author Info
Christian Ewerhart
Nuno Cassola
Steen Ejerskov
Natacha Valla

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Abstract

This paper derives a central bank’s optimal liquidity supply towards a money market with an unrestricted lending facility. We show that when the effect of liquidity on market rates is not too small, and the monetary authority cares for both interest rates and liquidity conditions, then the optimal allotment policy may entail a discontinuous reaction to initial conditions. In particular, the model predicts a threshold level of liquidity below which the central bank will not bail out the banking system. An estimation of the liquidity effect for the euro area suggests that the discontinuity might have contributed to the Eurosystem’s tight response to occurrences of underbidding during the period June 2000 through March 2004.

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Paper provided by Institute for Empirical Research in Economics - IEW in its series IEW - Working Papers with number iewwp201.

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Handle: RePEc:zur:iewwpx:201

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Related research
Keywords: open market operations; liquidity effect; standing facilities; underbidding;

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Find related papers by JEL classification:
E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Determination of Interest Rates; Term Structure of Interest Rates
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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  1. Ho, Thomas S Y & Saunders, Anthony, 1985. " A Micro Model of the Federal Funds Market," Journal of Finance, American Finance Association, vol. 40(3), pages 977-88, July. [Downloadable!] (restricted)
  2. Juan Ayuso & Rafael Repullo, 2003. "A Model of the Open Market Operations of the European Central Bank," Economic Journal, Royal Economic Society, vol. 113(490), pages 883-902, October. [Downloadable!] (restricted)
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  3. Hamilton, James D, 1996. "The Daily Market for Federal Funds," Journal of Political Economy, University of Chicago Press, vol. 104(1), pages 26-56, February. [Downloadable!] (restricted)
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  4. Hamilton, James D, 1997. "Measuring the Liquidity Effect," American Economic Review, American Economic Association, vol. 87(1), pages 80-97, March. [Downloadable!] (restricted)
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  5. Christian Ewerhart & Nuno Cassola & Steen Ejerskov & Natacha Valla, 2003. "Optimal allotment policy in the eurosystem’s main refinancing operations?," Working Paper Series 295, European Central Bank. [Downloadable!]
  6. Bartolini, Leonardo & Bertola, Giuseppe & Prati, Alessandro, 2002. "Day-to-Day Monetary Policy and the Volatility of the Federal Funds Interest Rate," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(1), pages 137-59, February.
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  7. Leonardo Bartolini & Giuseppe Bertoli & Alessandro Prati, 2000. "Banks' Reserve Management, Transaction Costs, and the Timing of Federal Reserve Intervention," Econometric Society World Congress 2000 Contributed Papers 0123, Econometric Society. [Downloadable!]
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  2. Fehr, Ernst & Singer, Tania, 2005. "The Neuroconomics of Mind Reading and Empathy," CEPR Discussion Papers 5128, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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This page was last updated on 2009-11-26.

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