Scientific Monographs, Bank of Finland
No E:26/2003:
Central bank tenders: three essays on money market liquidity auctions
Tuomas Välimäki ()
Abstract: Most OECD central banks implement monetary policy by
supplying reserves to the banking sector with the aim of influencing
short-term interbank interest rates. To interpret the monetary policy
stance accurately, one needs to be familiar with the mechanism for
determining the money market equilibrium. The aim of this study is to
deepen our understanding of the various effects of different intervention
styles on the short-term money market when monetary policy is implemented
with an operational framework similar to that of the European Central Bank
(ECB).
In the first essay of this study, we model banks' demand for
central bank reserves (liquidity) for each day of an n-day reserve
maintenance period and analyse liquidity determination under alternative
liquidity policy rules that a central bank might apply in fixed rate
tenders. It is shown that there is a tradeoff between the central bank's
ability to keep a market interest rate close to the tender rate and the
stability of liquidity holdings within a maintenance period. The second
essay presents a model of a single bank's optimal bidding in the context of
fixed rate liquidity tenders. It is shown that banks' bidding crucially
depends on the central bank's liquidity policy for tender allotments. This
essay also analyses ECB liquidity policy in terms of the model. The final
essay models the money market equilibrium and analyses banks' bidding when
the central bank uses variable rate tenders. The liquidity supply is fully
endogenised by having the central bank minimise a loss function the
includes deviations-from-target of interest rate and liquidity. ECB
experiences with variable rate tenders are also studied in this essay.
Keywords: central bank operational framework; short-term interest rates; money markets; tenders; liquidity policy; bidding; (follow links to similar papers)
JEL-Codes: E43; E58; G21; (follow links to similar papers)
235 pages, April 25, 2003
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