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Optimal Allotment Policy in Central Bank Open Market Operations

Author

Listed:
  • Christian Ewerhart
  • Nuno Cassola
  • Steen Ejerskov
  • Natacha Valla

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.

Suggested Citation

  • Christian Ewerhart & Nuno Cassola & Steen Ejerskov & Natacha Valla, "undated". "Optimal Allotment Policy in Central Bank Open Market Operations," IEW - Working Papers 201, Institute for Empirical Research in Economics - University of Zurich.
  • Handle: RePEc:zur:iewwpx:201
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    File URL: http://www.econ.uzh.ch/static/wp_iew/iewwp201.pdf
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    References listed on IDEAS

    as
    1. 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.
    2. Hamilton, James D, 1997. "Measuring the Liquidity Effect," American Economic Review, American Economic Association, vol. 87(1), pages 80-97, March.
    3. Bartolini, Leonardo & Bertola, Giuseppe & Prati, Alessandro, 2001. "Banks' reserve management, transaction costs, and the timing of Federal Reserve intervention," Journal of Banking & Finance, Elsevier, vol. 25(7), pages 1287-1317, July.
    4. 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.
    5. Würtz, Flemming Reinhardt, 2003. "A comprehensive model on the euro overnight rate," Working Paper Series 207, European Central Bank.
    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 137-159, February.
    7. Cassola, Nuno & Ejerskov, Steen & Ewerhart, Christian & Valla, Natacha, 2003. "Optimal allotment policy in the Eurosystem's main refinancing operations," Working Paper Series 295, European Central Bank.
    8. 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 977-988, July.
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    Citations

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    Cited by:

    1. Ewerhart, Christian & Cassola, Nuno & Valla, Natacha, 2012. "Overbidding in fixed rate tenders: The role of exposure risk," Journal of Banking & Finance, Elsevier, vol. 36(2), pages 539-549.
    2. Fehr, Ernst & Fischbacher, Urs & Kosfeld, Michael, 2005. "Neuroeconomic Foundations of Trust and Social Preferences," IZA Discussion Papers 1641, Institute for the Study of Labor (IZA).
    3. Tania Singer & Ernst Fehr, 2005. "The Neuroeconomics of Mind Reading and Empathy," American Economic Review, American Economic Association, vol. 95(2), pages 340-345, May.
    4. Ewerhart, Christian & Cassola, Nuno & Valla, Natacha, 2010. "Declining valuations and equilibrium bidding in central bank refinancing operations," International Journal of Industrial Organization, Elsevier, vol. 28(1), pages 30-43, January.
    5. Bruno S. Frey & Simon Luechinger & Alois Stutzer, 2007. "Calculating Tragedy: Assessing The Costs Of Terrorism," Journal of Economic Surveys, Wiley Blackwell, vol. 21(1), pages 1-24, February.
    6. Armin Falk & Ernst Fehr & Christian Zehnder, "undated". "The Behavioral Effects of Minimum Wages," IEW - Working Papers 247, Institute for Empirical Research in Economics - University of Zurich.

    More about this item

    Keywords

    open market operations; liquidity effect; standing facilities; underbidding;

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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