What Explains the Spread between the Euro Overnight Rate and the ECB's Policy Rate?

Abstract

Die Dis cus si on Pape rs die nen einer mög lichst schnel len Ver brei tung von neue ren For schungs arbei ten des ZEW. Die Bei trä ge lie gen in allei ni ger Ver ant wor tung der Auto ren und stel len nicht not wen di ger wei se die Mei nung des ZEW dar.Dis cus si on Papers are inten ded to make results of ZEW research prompt ly avai la ble to other eco no mists in order to encou ra ge dis cus si on and sug gesti ons for revi si ons. The aut hors are sole ly respon si ble for the con tents which do not neces sa ri ly repre sent the opi ni on of the ZEW.Download this ZEW Discussion Paper from our ftp server:ftp://ftp.zew.de/pub/zew-docs/dp/dp07076.pdf Non-technical SummaryThe European Central Bank (ECB) implements monetary policy by conducting open market operations to steer the short term interest rates in the interbank market, managing the liquidity situation in the market and signalling the monetary policy stance. In particular, the euro overnight rate, the market interest rate that is most closely linked to the policy rate, is crucial for signalling the policy stance since the overnight rate marks the first step in the monetary policy transmission process. Therefore, it is desirable for the ECB to keep the EONIA in close distance to the policy rate.The spread between the EONIA and the ECB's policy rate has widened slowly but steadily since the introduction of the changes to the operational framework The analysis identifies possible driving forces underlying the evolution of the spread over time and aims to quantify the impact of specific factors on the observed upward shift. We show that the increase in the EONIA spread can for the largest part be explained by the current liquidity deficit. Moreover, tight liquidity conditions as well as an increase in banks' uncertainty about the liquidity conditions lead to a significant upward pressure on the spread. ECB's liquidity policy only has a significant impact on the reduction of the spread if a loose policy is conducted during the last week of an MRO. Interestingly, interest rate expectations have not been found to have an important influence.

POLONIA dynamics during the years 2006–2012 and the effectiveness of the monetary Policy of the National Bank of Poland

“…If the ARCH test (Engle 1982) for standardized residuals revealed heteroscedasticity, we modeled the nonlinear dependencies via SV model (see the ''Appendix'' for details). Based upon the findings in the literature (Wuertz 2003;Linzert and Schmidt 2008;Schianchi and Verga 2006;Abbassi and Nautz 2010), as well as our previous findings (Kliber et al 2011;Kliber and Płuciennik 2011a) we decided to use the following explanatory variables:…”

“…In this sense the WIBOR rate is the transactional one (for more details see-ACI Polska webpage). 5 Linzert and Schmidt (2008), in order to explain the dynamics of EONIA spread, used a variable bid-tocover ratio which is defined as the ratio between the total bid volume of monetary bills and the amount covered. It is interpreted as a degree to which the liquidity surplus is absorbed by the central bank.…”

Asymmetric Standing Facilities: An Unexploited Monetary Policy Tool

“…He points out the importance of the size of the open market operations for the uncertainty of the outcome of the liquidity auction and links it to the increase in the price of the bids. His theoretical results are corroborated, among others, by the empirical applications of Linzert and Schmidt [15]. Finally, the implications of the recent financial crisis on the Euro money markets are analyzed in Cassola and Morana [3], Eisenschmidt, Hirsch and Linzert [6] as well as Eisenschmidt and Tapking [5].…”

Monetary transmission right from the start: On the information content of the Eurosystem's main refinancing operations

“…This central aim of monetary policy implementation has never been an easy task. Even before the financial crisis, a puzzling and unintended upward trend in the spread between the European overnight rate (Eonia) and the MRO rates indicated that the monetary transmission mechanism is not sufficiently understood, see Linzert and Schmidt (2011). 1 Since the start of the financial crisis, spreads between the Eurosystem's main refinancing rates and the money market rates have been huge and persistent.…”