monetary policy tools of the european central bank · 2013. 8. 18. · monetary policy tools of the...

Monetary Policy Tools of the European Central Bank

SuSe 2013 Monetary Policy and EMU: Tools of Monetary Policy 1



Main refinancing operations:

• The Governing Council sets the interest rate that will be applied on the main refinancing operations.

• Private financial institutions make bids to obtain liquidity in exchange for delivering collateral.

• A fixed rate tender

• A variable rate tender

Latest Euro Open Market Operations


Reference Operation

1 Operation currency

Settlement date

Maturity date Duration (days)

Minimum Rate (bids)

Marginal/ Fixed Rate

Weighted

Average

Rate

Allotted amount

Type

20120034 LTRO EUR 01/03/2012 26/02/2015 1092 529.53081 bn Ann. All.





20130072 LTRO EUR 10/04/2013 08/05/2013 28 0.75 % 5.1594 bn Ann. All.

20130082 MRO EUR 24/04/2013 02/05/2013 8 0.75 % 110.4069 bn Ann. All.

1) MRO = Main Refinancing Operations, LTRO = Long Term Refinancing Operations

http://www.ecb.europa.eu/mopo/implement/omo/html/20120034_ann.en.html

http://www.ecb.europa.eu/mopo/implement/omo/html/20120034_all.en.html













Advantages of Open Market Operations

• The central bank has complete control over the volume

• Flexible and precise

• Easily reversed

• Quickly implemented




• Reserve Requirements

• 2% of the total amount of checking deposits and other short-term deposits

• Pays interest on those deposits so cost of complying is low



Standing facilities:

• Aim to provide and absorb overnight liquidity.

• Banks can use the marginal lending facility to obtain overnight liquidity from the NCBs.

• Banks can use the deposit facility to make overnight deposits.

Advantages and Disadvantages of Marginal Lending Facility

• Lender of last resort to prevent financial panics

Creates moral hazard problem

• Cannot be controlled by the central bank; the decision maker is the bank

• Marginal lending rate is used as a backup facility to prevent the policy rate from rising too far above the target and provide liquidity during financial crisis


Key ECB Interest Rates


Disadvantages of Reserve Requirements

• Can cause liquidity problems

• Increases uncertainty for banks


Central Bank Balance Sheet Structure


Asset Structure of different Central Banks


Source:

Sachverständigenrat

Central Bank’s Simplified Balance Sheet

•Liabilities

Currency in circulation: in the hands of the public

Reserves: bank deposits at the central bank and vault cash

•Assets

Government securities: holdings by the central bank that affect money supply and earn interest

Discount loans: provide reserves to banks and earn the discount rate

Central Bank

Assets Liabilities

Securities Currency in circulation

Loans to Financial

Institutions

Reserves

SuSe 2013 Monetary Policy and EMU: The Money Supply Process 13

Control of the Monetary Base


• The effect of an open market purchase on the monetary base is an increase by the amount of the purchase

• The effect of an open market sale on the monetary base is a decrease by the amount of the sale


Control of the Monetary Base

Overview of The Central Bank’s Ability to Control the Monetary Base

• Open market operations are controlled by the central bank

• The central bank cannot determine the amount of borrowing by banks from the central bank

• Split the monetary base into two components

NBR= MB - BR

• The money supply is positively related to both the non-borrowed monetary base NBR and to the level of borrowed reserves, BR, from the central bank


Factors that Determine the Money Supply


M m MB

The Money Multiplier

• Define money as currency plus checkable deposits: M1

• Link the money supply (M) to the monetary base (MB) and let m be the money multiplier

where c is the currency holding ratio, e is the excess reserve holding ratio and r is the required reserves ratio.


Figure: M1 and the Monetary Base, 2007-2009

Source: Federal Reserve; www.federalreserve.gov/releases.


http://www.federalreserve.gov/releases

Figure: Excess Reserves Ratio and Currency Ratio, 2007-2009

Source: Federal Reserve; www.federalreserve.gov/releases.


http://www.federalreserve.gov/releases

The Market For Reserves and the Overnight Cash Rate

• Demand and Supply in the Market for Reserves

• What happens to the quantity of reserves demanded by banks, holding everything else constant, as the overnight cash rate changes?

• Excess reserves are insurance against deposit outflows

The cost of holding these is the interest rate that could have been earned minus the interest rate that is paid on these reserves, ier


Demand in the Market for Reserves

• Interest is paid on reserves at a level that is set at a fixed amount below the target policy rate (i on excess reserves)

• When the overnight cash rate is above the interest rate paid on excess reserves, ier, as the overnight cash rate decreases, the opportunity cost of holding excess reserves falls and the quantity of reserves demanded rises

• Downward sloping demand curve that becomes flat (infinitely elastic) at ier


Supply in the Market for Reserves

• Two components: non-borrowed and borrowed reserves

• Cost of borrowing from the central bank is the interest rate paid on marginal lending facility (id)

• Borrowing from the central bank is a substitute for borrowing from other banks

• If iff < id, then banks will not borrow from the central bank and borrowed reserves are zero

• The supply curve will be vertical

• As iff rises above id, banks will borrow more and more at id, and re-lend at iff

• The supply curve is horizontal (perfectly elastic) at id


Figure: Equilibrium in the Market for Reserves


Overnight

cash rate

ier

Reserves, R

How Changes in the Tools of Monetary Policy Affect the Overnight Cash Rate

• Effects of an open market operation depends on whether the supply curve initially intersects the demand curve in its downward sloped section versus its flat section.

• An open market purchase causes the overnight cash rate to fall whereas an open market sale causes the key policy rate to rise (when intersection occurs at the downward sloped section).

• Open market operations have no effect on the overnight cash rate when intersection occurs at the flat section of the demand curve.


Figure: Response to an Open Market Operation


ier

Overnight

cash rate

Overnight

cash rate

• If the intersection of supply and demand occurs on the vertical section of the supply curve, a change in the marginal lending rate will have no effect on the overnight cash rate.

• If the intersection of supply and demand occurs on the horizontal section of the supply curve, a change in the marginal lending rate shifts that portion of the supply curve and the overnight cash rate may either rise or fall depending on the change in the marginal lending rate



Figure: Response to a Change in the Marginal Lending Rate


ier ier

Overnight

cash rate

Overnight

cash rate

• When the central bank raises reserve requirement, the overnight cash rate rises and when the central bank decreases reserve requirement, the overnight cash rate falls.



Figure: Response to a Change in Required Reserves


ier

Overnight

cash rate

• Effects of a change in the interest rate that the central bank pays on reserves depends on whether the supply curve initially intersects the demand curve in its downward sloped section or its flat section.

• A rise in the interest on reserves has no effect on the overnight cash rate when the supply curve intersects the demand curve on its downward sloping section. However, if the intersection is on its flat section, a rise in the interest on reserves raises the overnight cash rate.



Figure: Response to a Change in the Interest Rate on Reserves


Overnight

cash rate Overnight

cash rate

Figure: How the Central Bank’s Operating Procedures Limit Fluctuations in the Overnight Cash Rate


Overnight

cash rate

monetary policy tools of the european central bank · 2013. 8. 18. · monetary policy tools of the...

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