The Euro Area Interbank Market and the Liquidity Management of the Euro System in the Financial crisis by Achim Hauck and Ulrike Neyer
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1 The Euro Area Interbank Market and the Liquidity Management of the Euro System in the Financial crisis by Achim Hauck and Ulrike Neyer Discussion by Laurent Clerc (Banque de France) The views presented in this discussion are those of the author and not necessarily those of the Banque de France The Future of Monetary Policy Banca d'italia Banque de France Einaudi Institute for Economics and Finance (EIEF) 1
2 Outline 1. Overview of the paper 2. Discussion 3. Policy implications Christian Bordes and Laurent Clerc : The art of central banking of the ECB and the separation principle, WP 290, August france.fr/gb/publications/ner/1 290.htm The Future of Monetary Policy Banca d'italia Banque de France Einaudi Institute for Economics and Finance (EIEF) 2
3 1. Overview The paper is about the functionning of the Eurosystem monetary policy operational framework Main characteristic: it is a symmetric interest rate corridor system The Future of Monetary Policy Banca d'italia Banque de France Einaudi Institute for Economics and Finance (EIEF) 3
4 Interest rate Marginal lending facility rate Minimum bid rate at MRO Deposit facility rate Demand for 1 reserves ( i CF + α i DF ) B marg = 2 γ Tradeoff stability in short term interest rate/better liquidity management Monetary policy: i IBM as close as possible to the policy rate (narrow corridor) Financial stability: provide incentive to banks to care about their liquidity management (wide corridor) The Future of Monetary Policy Banca d'italia Banque de France Einaudi Institute for Economics and Finance (EIEF) 4
5 How to get reserves? Step 1: MRO (weekly operations) Step 2: marginal lending/deposit facilities or interbank market The model is solved backward (step2) Interest rate Marginal lending facility rate Minimum bid rate at MRO CF i i IBM +γ + α ( A K) Deposit facility rate i CF + α i B = γ IBM The Future of Monetary Policy Banca d'italia Banque de France Einaudi Institute for Economics and Finance (EIEF) 5
6 Equilibrium (step 2) Bank a is in surplus: no transaction on the interbank market (i DF prevails) Bank a has a deficit but this deficit is below bank s b surplus: then downward pressure on i IBM Bank a has a deficit which exceeds bank s b surplus: upward pressure on i IBM Bank a s deficit = bank b s surplus: the market is close to the minimum bid rate Interest rate Marginal lending facility rate i CF + α γ B * Minimum bid rate at MRO Deposit facility rate i DF + γ B * The Future of Monetary Policy Banca d'italia Banque de France Einaudi Institute for Economics and Finance (EIEF) 6
7 Step 1: Open market operations K b =0, virtually by construction as bank b in surplus 3 regimes a)k a =D: market rate near MRO rate Bank a borrows in the interbank market For bank b to lend in the market, expected marginal return must exceed i DF 1 CF DF ( i + α i ) Condition met only if γ 2 = γ b)k a >D and A a H K Bank a expands borrowing over D corresponds to B marg γ < γ < γ E a ( A ) D The Future of Monetary Policy Banca d'italia Banque de France Einaudi Institute for Economics and Finance (EIEF) 7
8 c) last case A K > a H marg bank a covers part of its remaining liquidity need at the credit facility B corresponds to high transaction costs The Future of Monetary Policy Banca d'italia Banque de France Einaudi Institute for Economics and Finance (EIEF) 8
9 2. Discussion 2 preliminary comments For the reader, should better distinguish liquidity deficit and excess reserves Should present the functionning of the operational framework in normal time and then in crisis period The Future of Monetary Policy Banca d'italia Banque de France Einaudi Institute for Economics and Finance (EIEF) 9
10 The Future of Monetary Policy Banca d'italia Banque de France Einaudi Institute for Economics and Finance (EIEF) 10
11 The Future of Monetary Policy Banca d'italia Banque de France Einaudi Institute for Economics and Finance (EIEF) 11
12 The authors do not fully account for the implications of the Fixed Rate Full Allotment and the provision of liquidity at 1 year Interest rate Marginal lending facility rate Minimum bid rate at MRO FRFA=1% Deposit facility rate B marg = 1 2 ( 1% + α i DF ) γ The Future of Monetary Policy Banca d'italia Banque de France Einaudi Institute for Economics and Finance (EIEF) 12
13 Does the model explain the full period or only the period from 8 October 2008 to 31 January 2009? Period during which rate corridor narrowed to 50 bp The Future of Monetary Policy Banca d'italia Banque de France Einaudi Institute for Economics and Finance (EIEF) 13
14 1 year Long Term Refinancing Operation means that bank b can insure against future unexpected liquidity shocks = precautionary saving (K b 0) Bank a does not borrow anymore at the marginal lending facility, nor on the interbank market 2 tier market (separating equilibrium): peer monitoring à la Rochet Tirole bank a only rely only on ECB s refinancing operations Bank b parks all its excess reserve at the deposit facility (can still borrow in the interbank market) The Future of Monetary Policy Banca d'italia Banque de France Einaudi Institute for Economics and Finance (EIEF) 14
15 Consequently, the separation principle collapses Eurosystem and EONIA refi rates MRO: minimum bid rate MRO: fixed rate Marginal lending rate Deposit facility The Future of Monetary Policy Banca d'italia Banque de France Einaudi Institute for Economics and Finance (EIEF) 15
16 3. Policy implications Situation might be more tricky than the one describe in the paper CB cannot reactivate the market by increasing the intermediation cost or collateral requirement : Bank a has become a persistent bank When 1 year LTROs will mature, excess reserves will vanish and bank b will need to bid at the MRO and i IBM will rise As long as the problem of persistent banks is not solved, difficult to exit from the FRFA The Future of Monetary Policy Banca d'italia Banque de France Einaudi Institute for Economics and Finance (EIEF) 16
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