Optimal Allotment Policy in Central Bank Open Market Operations

Christian Ewerhart, Nuno Cassola, Steen Ejerskov and Natacha Valla

No 201, IEW - Working Papers from Institute for Empirical Research in Economics - University of Zurich

Abstract: This paper derives a central bank�s optimal liquidity supply towards a money market with an unrestricted lending facility. We show that when the effect of liquidity on market rates is not too small, and the monetary authority cares for both interest rates and liquidity conditions, then the optimal allotment policy may entail a discontinuous reaction to initial conditions. In particular, the model predicts a threshold level of liquidity below which the central bank will not bail out the banking system. An estimation of the liquidity effect for the euro area suggests that the discontinuity might have contributed to the Eurosystem�s tight response to occurrences of underbidding during the period June 2000 through March 2004.

Keywords: open market operations; liquidity effect; standing facilities; underbidding (search for similar items in EconPapers)
JEL-codes: E43 E52 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (8)

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Journal Article: Optimal allotment policy in central bank open market operations (2009)
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