Working Paper: CEPR ID: DP2605
Authors: Juan Ayuso; Rafael Repullo
Abstract: We construct a model to analyse the two types of tender procedures used by the European Central Bank (ECB) in its open market operations. We assume that the ECB minimizes the expected value of a loss function that depends on the quadratic difference between the interbank rate and a target interest rate that characterizes the stance of monetary policy. We show that when the loss function penalizes more heavily interbank rates below the target, fixed rate tenders have a unique equilibrium characterized by extreme overbidding. We also show that variable rate tenders have multiple equilibria characterized by varying degrees of overbidding, and that in these tenders an equilibrium without overbidding can be obtained by preannouncing the intended liquidity injection. Finally, our empirical analysis supports the assumption of an asymmetric loss function for the ECB.
Keywords: European Central Bank; Monetary Auctions; Monetary Policy Instruments; Open Market Operations; Tender Procedures
JEL Codes: D44; E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| ECB's loss function (E52) | restrictive liquidity supply (E51) |
| restrictive liquidity supply (E51) | banks overbid in fixed rate tenders (E52) |
| ECB's loss function (E52) | banks overbid in fixed rate tenders (E52) |
| switch to variable rate tenders (E43) | change in bidding behavior (D44) |
| type of tender procedures (H57) | bidding outcomes (D44) |