Why the effective price for money exceeds the policy

Wo r k i n g Pa p e r S e r i e s
no 981 / DeceMBer 2008
Why the effective
price for money
exceeds the policy
rate in the ECB
tenders?
by Tuomas Välimäki
WO R K I N G PA P E R S E R I E S
N O 9 81 / D E C E M B E R 20 0 8
ECB WORKSHOP
ON THE ANALYSIS OF
THE MONEY MARKET
WHY THE EFFECTIVE PRICE FOR
MONEY EXCEEDS THE POLICY
RATE IN THE ECB TENDERS?1
Tuomas Välimäki 2
In 2008 all ECB
publications
feature a motif
taken from the
10 banknote.
This paper can be downloaded without charge from
http://www.ecb.europa.eu or from the Social Science Research Network
electronic library at http://ssrn.com/abstract_id=1310618.
1 Comments and suggestions from Kai Sotamaa are gratefully acknowledged. The views expressed in this paper are solely the responsibility of the
author and should not be interpreted as reflecting the views of the Bank of Finland or the European Central Bank.
2 Suomen Pankki, P.O. Box 160, FIN-00101 Helsinki, Finland; e-mail: [email protected]
ECB WORKSHOP ON THE ANALYSIS OF THE MONEY MARKET
On 14 and 15 November 2007, Alain Durré, Huw Pill and Diego Rodriguez-Palenzuela of the ECB’s
Monetary Policy Stance Division organised a central bank workshop titled “The Analysis of the Money
Market: Role, Challenges and Implications from the Monetary Policy Perspective”. This workshop
provided an opportunity for participating central bank experts to exchange views and foster debate, also
in interaction with international organizations and academic institutions. The first day of the workshop
addressed issues related to the macro-perspective of the money market, drawing on the experiences of a
large number of countries. The second day adopted a micro-perspective on the money market, looking
in particular at trading behaviour in the overnight money market and its implications for the evolution
of spreads.
A first version of this paper was presented at this workshop. The papers presented at the time of the
workshop did not consider the potential implications of the financial turmoil for the results of the
paper, given that the tensions in money markets emerged in August 2007. The published version of
these papers represents an update of the original paper, which incorporates the discussion which took
place at the workshop and in most cases a discussion on the developments in the money markets since
August 2007.
© European Central Bank, 2008
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All rights reserved.
Any reproduction, publication and
reprint in the form of a different
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whether
printed
or
produced electronically, in whole or in
part, is permitted only with the explicit
written authorisation of the ECB or the
author(s).
The views expressed in this paper do not
necessarily reflect those of the European
Central Bank.
The statement of purpose for the ECB
Working Paper Series is available from
the ECB website, http://www.ecb.europa.
eu/pub/scientific/wps/date/html/index.
en.html
ISSN 1561-0810 (print)
ISSN 1725-2806 (online)
CONTENTS
Abstract
4
Non-technical summary
5
1 Introduction
6
2 The monetary policy implementation framework 10
2.1 Reserve requirements, standing facilities
and the determination of the overnight rate 10
2.2 Supply of liquidity and banks behavior
in ECB tender operations
12
3 Stylized facts on euro short-terminterest rates
3.1 EONIA spread
3.2 Tender spread
3.3 Liquidity supply
14
14
17
18
4 Potential explanations for the tender spread
4.1 Decrease in interest rate elasticity
4.2 Individual allotment uncertainty
20
20
23
5 Tentative empirical evidence
5.1 Structural demand for deposit facility
5.2 Individual allotment uncertainty
28
28
30
6 Summary and conclusions
30
References
34
European Central Bank Working Paper Series
36
ECB
Working Paper Series No 981
December 2008
3
Abstract
The tender spread, i.e. the difference between the effective price for money in the
ECB’s main refinancing operations and the prevailing policy rate, is one of the main
determinants behind the evolution of the EONIA with respect to the ECB’s
operational target. This study assesses the reasons for which the average tender spread
did not reduce after the banks’ demand for liquidity was isolated from their interest
rate expectations in March 2004. The paper offers two potential explanations for the
unexpected behavior. First, following the increased precision in the ECB’s liquidity
provision after the end-ofperiod fine tuning operations were added to the regularly
applied tools, even a small bias in the liquidity supply could have resulted in a strictly
positive tender spread. Second, banks’ uncertainty over their individual allotments in
the tender operations may have led to a strictly positive tender spread. Furthermore,
the significant growth in the refinancing volumes may have intensified the allotment
uncertainty.
Keywords: main refinancing operations, liquidity, EONIA, tenders
JEL Classification: D44, E58
4
ECB
Working Paper Series No 981
December 2008
Non-Technical Summary
The interbank overnight rate is the focal point of the money markets, as it is the starting
point of the term structure of interest rates. The importance of the overnight market is
further emphasized by the fact that the overnight rate is widely used as an operational
target for the monetary policy implementation. To interpret correctly the information
contained in the evolution of the overnight rate, one needs to understand all relevant
determinants affecting this rate. This study analyzes the behavior of the difference between
the effective price for money and the monetary policy steering rate (the tender spread) in
the euro area. The tender spread is one of the key drivers behind the evolution of the
EONIA with respect to the policy rate.
Previously, it has been shown that, banks' expectations on intra reserve maintenance period
changes in the official interest rates result in a non-zero average tender spread. In March
2004, the timing of the reserve maintenance periods was adjusted so that possible rate
changes now coincide with the change of the periods. This should have isolated banks'
demand for central bank reserves form their interest rate expectations. Whereas the
stability of the shortest rates was improved after the March 2004 reform, the tender spread
did not vanish. Contrary to ex ante expectations, the mean difference between the effective
price for money and the ECB policy rate was wider in 2005 and 2006 than in any single
year after 2000, when the ECB switched from fixed to variable rate liquidity tenders.
This paper offers two explanations for the unexpected behavior of the effective tender rate.
First, the interest rate elasticity of the demand for liquidity in the final central bank
operation has decreased considerably after the ECB has de facto added final day fine
tuning operations to its regularly used procedures. When this is combined with the ECB's
quantity oriented liquidity policy, it is possible that even a small bias (genuine or
perceived) in the liquidity supply may result in a strictly positive tender spread. Second, we
argue that banks' risk aversion and money market inefficiencies may result in a strictly
positive tender spread even, if the central bank liquidity supply was unbiased and the banks
did not anticipate any intra period rate changes. Here, the driving force behind the tender
spread would be uncertainty over the individual allotments in the ECB operations.
Furthermore, we show that the maximum spread resulting from this kind of allotment
uncertainty is positively related to the refinancing volumes that were doubled in the March
2004 reform.
ECB
Working Paper Series No 981
December 2008
5
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12
ECB
Working Paper Series No 981
December 2008
1B?E>4 9D 9> D85 K>1< $(& ?6 1 > CE38 1 31C5 D85 =1B79>1< $(& B1D5
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ECB
Working Paper Series No 981
December 2008
13
97EB5 *85 &% 1>4 D85 ?N391< B1D5C
%
1 = Fixed Tender rate / Minimum bid rate, 2 = Marginal lending rate,
3 = Deposit rate, 4 = EONIA
6
2
5
4
1
4
3
3
2
1
0
1.1.1999
1.1.2001
1.1.2003
1.1.2005
1.1.2007
Source: Bank of Finland
38+)9%$ &!#32 .- %41. 2(.133%1, )-3%1%23 1!3%2
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14
ECB
Working Paper Series No 981
December 2008
97EB5 *85 &% C@B514 &% ;5I @?<93I B1D5
%
1.00
from fixed to
variable rate
tenders
more frequent end-ofperiod fine-tuning
March 2004 reform
0.75
0.50
0.25
0.00
-0.25
-0.50
-0.75
-1.00
1999
2000
2001
2002
2003
2004
2005
2006
2007
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December 2008
15
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16
ECB
Working Paper Series No 981
December 2008
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Working Paper Series No 981
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17
97EB5 *85 D5>45B C@B514 95 =1B79>1< $(& B1D5 $9>9=E= 294 B1D5
%
0.50
0.45
0.40
0.35
0.30
0.25
0.20
0.15
0.10
0.05
0.00
2000
2001
2002
2003
2004
2005
2006
2007
Source: Bank of Finland
F1B9129<9DI 9> 21>;CM 45=1>4 6?B <9AE949DI
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18
ECB
Working Paper Series No 981
December 2008
97EB5 %5D 177B571D5 EC5 ?6 CD1>49>7 6139<9D95C
EUR, million
15 000
10 000
5 000
0
-5 0001999 2000 2001 2002 2003 2004 2005 2006 2007
-10 000
-15 000
-20 000
net use on
deposit facility
20 000
net use on marginal
lending facility
25 000
-25 000
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19
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20
ECB
Working Paper Series No 981
December 2008
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Standard deviation = EUR 1bn
Standard deviation = EUR 5bn
0.4
0.35
0.3
0.25
0.2
0.15
0.1
0.05
0
-15
-12
-9
-6
-3
0
3
6
9
12
15
Liquidity shock distribution
inverse demand (st. dev. EUR 1bn)
inverse demand (st. dev. EUR 5bn)
Equilibrium market rate
5.5
5
4.5
4
3.5
3
2.5
-6
-4
-2
0
2
Expected liquidity imbalance
4
6
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Working Paper Series No 981
December 2008
21
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=1B; 1<<?D=5>D
inverse demand (st. dev. EUR 1bn)
5.5
inverse demand (st. dev. EUR 5bn)
Equilibrium market rate
5
4.5
4
3.5
3
2.5
-6
-4
-2
0
2
Expected liquidity imbalance
4
6
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28
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Working Paper Series No 981
December 2008
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ECB
Working Paper Series No 981
December 2008
29
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30
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Working Paper Series No 981
December 2008
97EB5 77B571D5 1<<?D=5>D 9> D85 =19> B5K>1>39>7 ?@5B1D9?>C
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Working Paper Series No 981
December 2008
31
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Working Paper Series No 981
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33
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Working Paper Series No 981
December 2008
35
European Central Bank Working Paper Series
For a complete list of Working Papers published by the ECB, please visit the ECB’s website
(http://www.ecb.europa.eu).
929 “Real convergence in Central and Eastern European EU Member States: which role for exchange rate volatility?”
by O. Arratibel, D. Furceri and R. Martin, September 2008.
930 “Sticky information Phillips curves: European evidence” by J. Döpke, J. Dovern, U. Fritsche and J. Slacalek,
September 2008.
931 “International stock return comovements” by G. Bekaert, R. J. Hodrick and X. Zhang, September 2008.
932 “How does competition affect efficiency and soundness in banking? New empirical evidence” by K. Schaeck and
M. Čihák, September 2008.
933 “Import price dynamics in major advanced economies and heterogeneity in exchange rate pass-through”
by S. Dées, M. Burgert and N. Parent, September 2008.
934 “Bank mergers and lending relationships” by J. Montoriol-Garriga, September 2008.
935 “Fiscal policies, the current account and Ricardian equivalence” by C. Nickel and I. Vansteenkiste,
September 2008.
936 “Sparse and stable Markowitz portfolios” by J. Brodie, I. Daubechies, C. De Mol, D. Giannone and I. Loris,
September 2008.
937 “Should quarterly government finance statistics be used for fiscal surveillance in Europe?” by D. J. Pedregal and
J. J. Pérez, September 2008.
938 “Channels of international risk-sharing: capital gains versus income flows” by T. Bracke and M. Schmitz,
September 2008.
939 “An application of index numbers theory to interest rates” by J. Huerga and L. Steklacova, September 2008.
940 “The effect of durable goods and ICT on euro area productivity growth?” by J. Jalava and I. K. Kavonius,
September 2008.
941 “The euro’s influence upon trade: Rose effect versus border effect” by G. Cafiso, September 2008.
942 “Towards a monetary policy evaluation framework” by S. Adjemian, M. Darracq Pariès and S. Moyen,
September 2008.
943 “The impact of financial position on investment: an analysis for non-financial corporations in the euro area”
by C. Martinez-Carrascal and A. Ferrando, September 2008.
944 “The New Area-Wide Model of the euro area: a micro-founded open-economy model for forecasting and policy
analysis” by K. Christoffel, G. Coenen and A. Warne, October 2008.
945 “Wage and price dynamics in Portugal” by C. Robalo Marques, October 2008.
946 “Macroeconomic adjustment to monetary union” by G. Fagan and V. Gaspar, October 2008.
947 “Foreign-currency bonds: currency choice and the role of uncovered and covered interest parity”
by M. M. Habib and M. Joy, October 2008.
36
ECB
Working Paper Series No 981
December 2008
948 “Clustering techniques applied to outlier detection of financial market series using a moving window filtering
algorithm” by J. M. Puigvert Gutiérrez and J. Fortiana Gregori, October 2008.
949 “Short-term forecasts of euro area GDP growth” by E. Angelini, G. Camba-Méndez, D. Giannone, L. Reichlin
and G. Rünstler, October 2008.
950 “Is forecasting with large models informative? Assessing the role of judgement in macroeconomic forecasts”
by R. Mestre and P. McAdam, October 2008.
951 “Exchange rate pass-through in the global economy: the role of emerging market economies” by M. Bussière and
T. Peltonen, October 2008.
952 “How successful is the G7 in managing exchange rates?” by M. Fratzscher, October 2008.
953 “Estimating and forecasting the euro area monthly national accounts from a dynamic factor model”
by E. Angelini, M. Bańbura and G. Rünstler, October 2008.
954 “Fiscal policy responsiveness, persistence and discretion” by A. Afonso, L. Agnello and D. Furceri, October 2008.
955 “Monetary policy and stock market boom-bust cycles” by L. Christiano, C. Ilut, R. Motto and M. Rostagno,
October 2008.
956 “The political economy under monetary union: has the euro made a difference?” by M. Fratzscher and L. Stracca,
November 2008.
957 “Modeling autoregressive conditional skewness and kurtosis with multi-quantile CAViaR” by H. White,
T.-H. Kim, and S. Manganelli, November 2008.
958 “Oil exporters: in search of an external anchor” by M. M. Habib and J. Stráský, November 2008.
959 “What drives U.S. current account fluctuations?” by A. Barnett and R. Straub, November 2008.
960 “On implications of micro price data for macro models” by B. Maćkowiak and F. Smets, November 2008.
961 “Budgetary and external imbalances relationship: a panel data diagnostic” by A. Afonso and C. Rault,
November 2008.
962 “Optimal monetary policy and the transmission of oil-supply shocks to the euro area under rational
expectations” by S. Adjemian and M. Darracq Pariès, November 2008.
963 “Public and private sector wages: co-movement and causality” by A. Lamo, J. J. Pérez and L. Schuknecht,
November 2008.
964 “Do firms provide wage insurance against shocks? Evidence from Hungary” by G. Kátay, November 2008.
965 “IMF lending and geopolitics” by J. Reynaud and J. Vauday, November 2008.
966 “Large Bayesian VARs” by M. Bańbura, D. Giannone and L. Reichlin, November 2008.
967 “Central bank misperceptions and the role of money in interest rate rules” by V. Wieland and G. W. Beck,
November 2008.
968 “A value at risk analysis of credit default swaps” by B. Raunig and M. Scheicher, November 2008.
969 “Comparing and evaluating Bayesian predictive distributions of asset returns” by J. Geweke and G. Amisano,
November 2008.
ECB
Working Paper Series No 981
December 2008
37
970 “Responses to monetary policy shocks in the east and west of Europe” by M. Jarociński, November 2008.
971 “Interactions between private and public sector wages” by A. Afonso and P. Gomes, November 2008.
972 “Monetary policy and housing prices in an estimated DSGE for the US and the euro area” by M. Darracq Pariès
and A. Notarpietro, November 2008.
973 “Do China and oil exporters influence major currency configurations?” by M. Fratzscher and A. Mehl,
December 2008.
974 “Institutional features of wage bargaining in 23 European countries, the US and Japan” by P. Du Caju, E. Gautier,
D. Momferatou and M. Ward-Warmedinger, December 2008.
975 “Early estimates of euro area real GDP growth: a bottom up approach from the production side” by E. Hahn
and F. Skudelny, December 2008.
976 “The term structure of interest rates across frequencies” by K. Assenmacher-Wesche and S. Gerlach,
December 2008.
977 “Predictions of short-term rates and the expectations hypothesis of the term structure of interest rates”
by M. Guidolin and D. L. Thornton, December 2008.
978 “Measuring monetary policy expectations from financial market instruments” by M. Joyce, J. Relleen and
S. Sorensen, December 2008.
979 “Futures contract rates as monetary policy forecasts” by G. Ferrero and A. Nobili, December 2008.
980 “Extracting market expectations from yield curves augmented by money market interest rates: the case of Japan”
by T. Nagano and N. Baba, December 2008.
981 “Why the effective price for money exceeds the policy rate in the ECB tenders?” by T. Välimäki, December 2008.
38
ECB
Working Paper Series No 981
December 2008
Wo r k i n g Pa p e r S e r i e s
N o 9 8 1 / D E Z E M B ER 2 0 0 8
Why the effective
price for money
exceeds the policy
rate in the ECB
tenders?
by Tuomas Välimäki

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Why the effective price for money exceeds the policy

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