monetary policy tools of the european central bank · 2013. 8. 18. · monetary policy tools of the...
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Monetary Policy Tools of the European Central Bank
SuSe 2013 Monetary Policy and EMU: Tools of Monetary Policy 1
Monetary Policy Tools of the European Central Bank
SuSe 2013 Monetary Policy and EMU: Tools of Monetary Policy 2
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
Monetary Policy Tools of the European Central Bank
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Latest Euro Open Market Operations
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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.
20110149 LTRO EUR 22/12/2011 29/01/2015 1134 489.19075 bn Ann. All.
20130086 LTRO EUR 25/04/2013 01/08/2013 98 2.9773 bn Ann. All.
20130063 LTRO EUR 28/03/2013 27/06/2013 91 9.1127 bn Ann. All.
20130040 LTRO EUR 28/02/2013 30/05/2013 91 8.3283 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
Advantages of Open Market Operations
• The central bank has complete control over the volume
• Flexible and precise
• Easily reversed
• Quickly implemented
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Monetary Policy Tools of the European Central Bank
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• 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
Monetary Policy Tools of the European Central Bank
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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
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Key ECB Interest Rates
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Disadvantages of Reserve Requirements
• Can cause liquidity problems
• Increases uncertainty for banks
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Central Bank Balance Sheet Structure
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Asset Structure of different Central Banks
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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
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• 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
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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
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Factors that Determine the Money Supply
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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.
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Figure: M1 and the Monetary Base, 2007-2009
Source: Federal Reserve; www.federalreserve.gov/releases.
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Figure: Excess Reserves Ratio and Currency Ratio, 2007-2009
Source: Federal Reserve; www.federalreserve.gov/releases.
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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
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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
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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
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Figure: Equilibrium in the Market for Reserves
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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.
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Figure: Response to an Open Market Operation
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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
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How Changes in the Tools of Monetary Policy Affect the Overnight Cash Rate
Figure: Response to a Change in the Marginal Lending Rate
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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.
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How Changes in the Tools of Monetary Policy Affect the Overnight Cash Rate
Figure: Response to a Change in Required Reserves
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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.
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How Changes in the Tools of Monetary Policy Affect the Overnight Cash Rate
Figure: Response to a Change in the Interest Rate on Reserves
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Overnight
cash rate Overnight
cash rate
Figure: How the Central Bank’s Operating Procedures Limit Fluctuations in the Overnight Cash Rate
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Overnight
cash rate