Workshop on Implementing monetary policy post-crisis: What ......FTO of 94.8 bn FTO of 61.1 bn FTO...
Transcript of Workshop on Implementing monetary policy post-crisis: What ......FTO of 94.8 bn FTO of 61.1 bn FTO...
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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2
The past
•Pre-August 2007
The ECB corridor before the crisis
• O/N rate in the middle of the corridor 3
4
Excess of liquidity and spreads before the crisis
• Excess liquidity and spread O/N MRO rate around
zero
5
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
0
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
Central bank balance sheets
Source: Central banks statements
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0
50
100
150
200
250
300
350
400
450
500Ja
n-0
7
May
-08
Sep
-09
Feb
-11
Jun-1
2
No
v-1
3
Ind
ex (
Ja
n 2
00
7=
10
0)
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
of the corridor
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 0
7
09
Aug 0
710
Aug 0
7
11
Aug 0
7
12
Aug 0
713
Aug 0
7
14
Aug 0
715
Aug 0
7
16
Aug 0
717
Aug 0
7
18
Aug 0
7
19
Aug 0
720
Aug 0
7
21
Aug 0
722
Aug 0
7
23
Aug 0
724
Aug 0
7
25
Aug 0
7
26
Aug 0
727
Aug 0
7
28
Aug 0
729
Aug 0
7
30
Aug 0
731
Aug 0
7
01
Sep 0
7
02
Sep 0
703
Sep 0
7
04
Sep 0
705
Sep 0
7
06
Sep 0
707
Sep 0
7
08
Sep 0
7
09
Sep 0
710
Sep 0
7
11
Sep 0
7
EU
R b
illi
on
s
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 bnFTO of
61.1 bn
FTO of
47.7 bn
FTO of
-60.0 bn
FTO of 42.2 bnMRO 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
of 40.0 bn
regular LTRO
of 50.0 bnMRO 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
0.2
0.4Ja
n-0
3
Au
g-0
3
Mar
-04
Sep
-04
Ap
r-05
Oct
-05
May
-06
No
v-0
6
Jun-0
7
Jan
-08
Jul-
08
Feb
-09
Au
g-0
9
Mar
-10
Sep
-10
Ap
r-11
No
v-1
1
May
-12
Dec
-12
Jun-1
3
Jan
-14
Jul-
14
bp
s
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)
0
500
1000
1500
2000
2500
3000
3500
4000
4500
5000
2016 2017 2018 2019 2020 2021 2022 2023
US
D b
n
Current accounts
Banknotes
Assets
0
1000
2000
3000
4000
5000
6000
2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028
EU
R b
n
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
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
on 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.
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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
on 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
Stra
dd
le p
ayo
ut
Average O/N rateCB 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
0,02
0,04
0,06
0,08
0,1
0,12
0,14
0,16
0,18
0,2
0 100 200 300 400 500 600 700
Straddle cap (% of cumulative AF volatility)
O/N rate volatility
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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