1 The past Pre-August 2007 2 The ECB corridor before the crisis - - PowerPoint PPT Presentation

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1 The past Pre-August 2007 2 The ECB corridor before the crisis - - PowerPoint PPT Presentation

Jan 25, 2024 361 likes •671 views

Workshop on Implementing monetary policy post-crisis: What have we learned? What do we need to know? Organized by Columbia University SIPA and the Federal Reserve Bank of New York May 4, 2016 How should central banks steer money market interest

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Workshop on Implementing monetary policy post-crisis: What have we learned? What do we need to know? Organized by Columbia University SIPA and the Federal Reserve Bank of New York May 4, 2016

How should central banks steer money market interest rates?

Francesco Papadia*

*This presentation represents work in progress. The section on derivative control of interest rate is joint work with Juliusz Jablecki Prepared with the assistance of Madalina Norocea and Piero Esposito

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The past

  • Pre-August 2007
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The ECB corridor before the crisis

  • O/N rate in the middle of the corridor

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Excess of liquidity and spreads before the crisis

  • Excess liquidity and spread O/N MRO rate around

zero

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Interest rates within a corridor system

Where is the market interest rate on day t is the interest rate at the end of the maintenance period is the expectation operator based on information available on day t is the rate applying when banks are long on liquidity and depositing it with the ECB is the probability of banks being long on liquidity at the end of the maintenance period is the rate when banks are short of liquidity and borrowing from the ECB is the probability of banks being short on liquidity at the end of the maintenance period.

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Penalty rate Target rate Required reserves Demand for reserves Reserve balances Interest rate Target supply

Monetary policy implementation in the United States*

*Todd Keister, Antoine Martin, and James McAndrews

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Central banks balance sheets broad vs. narrow frameworks

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Precision in interest rate control I

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Precision in interest rate control II

  • US and €-area with comparable precision, Japan

more precise, UK less.

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The Present

  • After August 2007
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Central bank balance sheets

Source: Central banks statements

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50 100 150 200 250 300 350 400 450 500 Jan-07 May-08 Sep-09 Feb-11 Jun-12 Nov-13 Index (Jan 2007=100) Eurosystem Federal Reserve Bank of England Bank of Japan

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The ECB corridor after the crisis First volatility of O/N, then compression onto the floor of the corridor

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Excess of liquidity after the crisis

  • Huge amount of liquidity pushing O/N to the bottom
  • f the corridor
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Fundamental equation: special case

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Maintenance period 8 August – 11 September 2007

  • 170.0
  • 150.0
  • 130.0
  • 110.0
  • 90.0
  • 70.0
  • 50.0
  • 30.0
  • 10.0

10.0 30.0 50.0 70.0 90.0 110.0 130.0 150.0 170.0 08 Aug 07 09 Aug 07 10 Aug 07 11 Aug 07 12 Aug 07 13 Aug 07 14 Aug 07 15 Aug 07 16 Aug 07 17 Aug 07 18 Aug 07 19 Aug 07 20 Aug 07 21 Aug 07 22 Aug 07 23 Aug 07 24 Aug 07 25 Aug 07 26 Aug 07 27 Aug 07 28 Aug 07 29 Aug 07 30 Aug 07 31 Aug 07 01 Sep 07 02 Sep 07 03 Sep 07 04 Sep 07 05 Sep 07 06 Sep 07 07 Sep 07 08 Sep 07 09 Sep 07 10 Sep 07 11 Sep 07 EUR billions 3.00 3.25 3.50 3.75 4.00 4.25 4.50 4.75 5.00 % Daily reserve surplus/deficit (left-hand scale) Average daily reserve surplus (left-hand scale) EONIA (right-hand scale)

FTO of 94.8 bn FTO of 61.1 bn FTO of 47.7 bn FTO of

  • 60.0 bn

FTO of 42.2 bn MRO with benchmark +5.0 bn FTO of 7.7 bn MRO with benchmar k +73.5 bn MRO with benchmark +46.0 bn MRO with benchmark +14.5 bn supplementary LTRO

  • f 40.0 bn

regular LTRO

  • f 50.0 bn

MRO with benchmark +1.0 bn

Source: ECB

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EONIA-MRO spread

Notes: (1) Lehman Brothers Collapse; Injection of liquidity via fine tuning operations (2) Narrowing of the corridor & Full allotment at fixed rate (3) 1st 1 year LTRO (4) Start of SMP (5) & (6)The 3 year LTROs (7) Deposit rate cut to 0 (8) Start of 3 yr LTROs early repayment (9) MRO rate cut (10) MRO rate cut to 0.25 (11) Negative deposit rate

  • 0.8
  • 0.6
  • 0.4
  • 0.2

0.2 0.4 Jan-03 Aug-03 Mar-04 Sep-04 Apr-05 Oct-05 May-06 Nov-06 Jun-07 Jan-08 Jul-08 Feb-09 Aug-09 Mar-10 Sep-10 Apr-11 Nov-11 May-12 Dec-12 Jun-13 Jan-14 Jul-14 bps

2 1 7 6 5 3 4 8 9 10 11

Source: ECB

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Spread between peripheral and German 10y bonds

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The new FED corridor approach

  • Corridor between two absorbing facilities
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And what about the future?

  • Just continue like now
  • Get back to old symmetric corridor
  • Derivative-based interest rate control
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Just continue like now Long term balance sheet extrapolations ECB (lhs); FED (rhs)

500 1000 1500 2000 2500 3000 3500 4000 4500 5000 2016 2017 2018 2019 2020 2021 2022 2023 USD bn Current accounts Banknotes Assets 1000 2000 3000 4000 5000 6000 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 EUR bn Current account Banknotes Assets

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Get back to old symmetric corridor

Liquidity control through OMOs No ex-ante excess liquidity Stabilizing required reserves Narrow or broad framework? In the US? In the €-area?

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Derivative-based interest rate control I

prepared with Juliusz Jablecki

  • Symmetric corridor
  • Rigid demand for liquidity
  • Stabilizing device needed
  • Daily OMOs
  • Draw from reserves required on average during maintenance

period

  • Draw from target rate facility (Taralac)
  • Compensate P/L effect through a straddle
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Derivative-based interest rate control II

  • In a Wicksellian approach the central bank wants to control the

interest rates, with quantities only a tool. Why not concentrating

  • n the variable of interest rather than on the tool?
  • Liquidity: turnover in contracts on € interest rates is twice as high

as that in cash market (both secured and unsecured);

  • Price origination: anecdotal evidence suggests pricing

increasingly originates in the derivative market (e.g bond futures);

  • Lower transactions costs: a 3M € unsecured deposit trades at ca.

15bp bid-ask spread vs. only 2-5bp on 3M OIS;

  • Lower credit risk: collateralization and netting arrangements

would allow limiting credit exposure. 23

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Derivative-based interest rate control III

  • CB offers protection against O/N volatility with a straddle, a combination of a

payer and receiver option with a strike equal to the CB target rate

  • The writing of straddle contracts complements normal liquidity provision based
  • n a given forecast of autonomous factors
  • The payout of the straddle is 0 if the O/N rate stabilizes exactly at the CB target

rate and increases linearly with deviations from the strike

Straddle payout Average O/N rate CB target rate

Banks are hedged against deviations of O/N rates from CB target

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Derivative-based interest rate control IV

A straddle because:

  • Banks have symmetric exposure to O/N rate deviations from target

if OMO covers expected shocks

  • A swap would only give one sided protection
  • Straddles are traded e.g. on 3M EURIBOR futures

EURIBOR future straddles are liquid and trade at narrow bid-ask spread

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Derivative-based interest rate control V

  • CB balances liquidity conditions with OMO & offers banks a

straddle with strike equal to target rate

  • Trading sessions take place and liquidity shocks materialize
  • If the banking system has a net liquidity shortfall/surplus, recourse

will be taken to the borrowing/deposit standing facility

  • All or part of the cost of taking recourse to either of the standing

facilities can be recovered.

Morning session Mid-day session Afternoon session

1st liquidity shock 2nd liquidity shock 3rd liquidity shock

COB OMO

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Derivative-based interest rate control VI

  • With a free of charge and limitless straddle, interest rates would be pegged at target.
  • A capped straddle will not eliminate interest rate volatility fully and will leave some

space for interbank market functioning

  • A cap calibrated to 200% of cumulative variance of daily liquidity shocks reduces

O/N volatility by a factor of 4.5

0,02 0,04 0,06 0,08 0,1 0,12 0,14 0,16 0,18 0,2 100 200 300 400 500 600 700 Straddle cap (% of cumulative AF volatility)

O/N rate volatility 27

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Derivative-based interest rate control VII

  • Isolate from effects of LCR as interest rate control is separate

from liquidity supply/demand?

  • Derivatives-based monetary policy implementation vs.

TARALAC facility

  • How to apportion the straddle to individual banks?
  • Should the straddle be offered free of charge?
  • How would a straddle-based approach influence money market

activity?

  • What about using fixed-floating swaps?

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My Blog:

Money matters? Perspectives on Monetary Policy

My Tweet:

@FrancescoPapad1

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Thank you!

…and some publicity