Fixed Rate Tenders and the Overnight Money Market Equilibrium

Abstract

This paper presents a general equilibrium model of the determination of equilibrium in the interbank market for overnight liquidity when the central bank uses fixed rate tenders in its liquidity provision. We consider three alternative liquidity policy rules. First, the central bank may provide the bid amounts in full. Alternatively, the central bank can scale back the bid amounts pro rata with the individual bids. For the latter case, we consider two target options for the central bank: liquidity or an interest rate. We show that the expected overnight rate remains more tightly in the hands of the central bank if the full allotment procedure or a pure interest rate targeting rule is used than if liquidity targeting is used. We will also demonstrate how optimal bidding in tender operations varies considerably according to which procedure is chosen by the central bank.

Liquidity Shocks in the Eurosystem Interbank Market

“…The model, based on Poole (1968), Välimäki (2003) and Pérez-Quirós and Rodríguez-Mendizábal (2006), links the equilibrium interest rate with the demand for liquidity. At optimal borrowing, the cost of financing from the market (given by interest rate i t ) is equal to the expected cost of financing with standing facilities in the future.…”

“…The setup of the model can already be considered standard and has been extensively described, for example, in Poole (1968), followed by Hamilton (1996) and, more recently, Pérez-Quirós and Rodríguez-Mendizábal (2006), Välimäki (2003) and Bartolini et al (2001), as well as my own papers.…”

“…The theoretical contributions include models of Pérez-Quirós and Rodríguez-Mendizábal (2006), Välimäki (2003), Clouse and Dow Jr. (2002) and Bartolini et al (2001) that focus on explaining the increase in the average level of the interest rate and interest rate volatility at the end of the maintenance period without using trade barriers. The models are constructed in a very similar way and all include so-called liquidity shock as defined initially by Poole (1968).…”

Multiple equilibrium overnight rates in a dynamic interbank market game

“…This method to assess the liquidity situation at the interbank market can easily be justiÞed theoretically. Ho and Saunders (1985) and Spindt and Hoffmeister (1988) for example discuss models of the Fed funds market, while Välimäki (2001), Quirós and Mendizábal (2001) and Tapking (2002) analyse models of the European interbank market. In all of these models, the equilibrium rate is the higher the more likely a liquidity deÞcit is.…”

Cross-Country Differences in Monetary Policy Execution and Money Market Rates' Volatility

“…Models allowing for central bank intervention are o ered by Nautz (1998), , and Valimaki (2003). These models, however, are tailored to the specific features of German, U.S., and Euro Zone markets, respectively, and lack the flexibility needed to explain cross-country di erences in interest rate behavior.…”