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The determinants of the overnight interest rate in the euro area

  • Moschitz, Julius

The overnight interest rate is the price paid for one day loans and defines the short end of the yield curve. It is the equilibrium outcome of supply and demand for bank reserves. This paper models the intertemporal decision problems in the reserve market for both central and commercial banks. All important institutional features of the euro area reserve market are included. The model is then estimated with euro area data. A permanent change in reserve supply of one billion euro moves the overnight rate by eight basis points into the opposite direction, hence, there is a substantial liquidity effect. Most of the predictable patterns for the mean and the volatility of the overnight rate are related to monetary policy implementation, but also some calendar day effects are present. Banks react sluggishly to new information. Implications for market efficiency, endogeneity of reserve supply and underbidding are studied. JEL Classification: E52, E58, E43

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Paper provided by European Central Bank in its series Working Paper Series with number 0393.

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Date of creation: Sep 2004
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Handle: RePEc:ecb:ecbwps:20040393
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  1. Cassola, Nuno & Morana, Claudio, 2003. "Volatility of interest rates in the euro area: evidence from high frequency data," Working Paper Series 0235, European Central Bank.
  2. Daniel L. Thornton, 2001. "Identifying the liquidity effect at the daily frequency," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 59-82.
  3. Ben S. Bernanke & Ilian Mihov, 1998. "The Liquidity Effect and Long-Run Neutrality," NBER Working Papers 6608, National Bureau of Economic Research, Inc.
  4. William Poole & Robert H. Rasche, 2000. "Perfecting the market's knowledge of monetary policy," Working Papers 2000-010, Federal Reserve Bank of St. Louis.
  5. Vitor Gaspar & Gabriel Pérez Quir? & Hugo Rodr?uez Mendiz?al, 2004. "Interest Rate Determination in the Interbank Market," UFAE and IAE Working Papers 603.04, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
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  7. 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.
  8. Ewerhart, Christian & Cassola, Nuno & Ejerskov, Steen & Valla, Natacha, 2004. "Liquidity, information, and the overnight rate," Working Paper Series 0378, European Central Bank.
  9. Quiros, Gabriel Perez & Mendizabal, Hugo Rodriguez, 2006. "The Daily Market for Funds in Europe: What Has Changed with the EMU?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(1), pages 91-118, February.
  10. Thornton, Daniel L., 2001. "The Federal Reserve's operating procedure, nonborrowed reserves, borrowed reserves and the liquidity effect," Journal of Banking & Finance, Elsevier, vol. 25(9), pages 1717-1739, September.
  11. Stracca, Livio & Ejerskov, Steen & Martin Moss, Clara, 2003. "How does the ECB allot liquidity in its weekly main refinancing operations? A look at the empirical evidence," Working Paper Series 0244, European Central Bank.
  12. Ewerhart, Christian & Cassola, Nuno & Ejerskov, Steen & Valla, Natacha, 2003. "Optimal allotment policy in the Eurosystem's main refinancing operations," Working Paper Series 0295, European Central Bank.
  13. James D. Hamilton, 1996. "Measuring the liquidity effect," Working Papers in Applied Economic Theory 96-06, Federal Reserve Bank of San Francisco.
  14. Julius Moschitz, 2004. "Monetary Policy Implementation and Volatility in the Euro Area Money Market," Money Macro and Finance (MMF) Research Group Conference 2004 95, Money Macro and Finance Research Group.
  15. Bindseil, Ulrich & Seitz, Franz, 2001. "The supply and demand for Eurosystem deposits - The first 18 months," Working Paper Series 0044, European Central Bank.
  16. 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.
  17. Simon Gilchrist, 2001. "Identifying the liquidity effect at the daily frequency (commentary)," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 59-82.
  18. Bindseil, Ulrich, 2002. "Equilibrium bidding in the Eurosystem's open market operations," Working Paper Series 0137, European Central Bank.
  19. Ewerhart, Christian, 2002. "A model of the Eurosystem's operational framework for monetary policy implementation," Working Paper Series 0197, European Central Bank.
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