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Central Bank Haircut Policy

Author Info

  • 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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File URL: http://www.bankofcanada.ca/wp-content/uploads/2010/10/wp10-23.pdf
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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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Keywords: Payment; clearing; and settlement systems; Central bank research; Monetary policy implementation; Financial system regulation and policies; Financial services;

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Find related papers by JEL classification:
  • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
  • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General

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  1. Berentsen, Aleksander & Monnet, Cyril, 2008. "Monetary policy in a channel system," Journal of Monetary Economics, Elsevier, vol. 55(6), pages 1067-1080, September.
  2. James T. E. Chapman & Antoine Martin, 2007. "Rediscounting Under Aggregate Risk with Moral Hazard," Working Papers 07-51, Bank of Canada.
  3. Jeffrey Lacker, 2001. "Online Appendix to Collateralized Debt as the Optimal Contract," Technical Appendices lacker01, Review of Economic Dynamics.
  4. Antoine Martin & Cyril Monnet, 2009. "Monetary policy implementation frameworks: a comparative analysis," Working Papers 09-27, Federal Reserve Bank of Philadelphia.
  5. Antoine Martin & James McAndrews, 2008. "Should there be intraday money markets?," Staff Reports 337, Federal Reserve Bank of New York.
  6. Jeffrey M. Lacker, 1998. "Collateralized debt as the optimal contract," Working Paper 98-04, Federal Reserve Bank of Richmond.
  7. Bhattacharya, Joydeep & Haslag, Joseph H. & Martin, Antoine, 2009. "Why does overnight liquidity cost more than intraday liquidity?," Journal of Economic Dynamics and Control, Elsevier, vol. 33(6), pages 1236-1246, June.
  8. Thorsten Koeppl & Cyril Monnet & Ted Temzelides, 2006. "A Dynamic Model of Settlement," Working Papers 1053, Queen's University, Department of Economics.
  9. Ricardo Lagos & Randall Wright, 2004. "A unified framework for monetary theory and policy analysis," Staff Report 346, Federal Reserve Bank of Minneapolis.
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Cited by:

  1. Aleksander Berentsen & Alessandro Marchesiani & Christopher Waller, 2014. "Floor Systems for Implementing Monetary Policy: Some Unpleasant Fiscal Arithmetic," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 17(3), pages 523-542, July.
  2. Sever, Can, 2014. "Systemic Liquidity Crisis with Dynamic Haircuts," MPRA Paper 55602, University Library of Munich, Germany.
  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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