Central Bank Haircut Policy
James Chapman (),
Jonathan Chiu () and
Miguel Molico ()
Staff Working Papers from Bank of Canada
We present a model of central bank collateralized lending to study the optimal choice of the haircut policy. We show that a lending facility provides a bundle of two types of insurance: insurance against liquidity risk as well as insurance against downside risk of the collateral. Setting a haircut therefore involves balancing the trade-off between relaxing the liquidity constraints of agents on one hand, and increasing potential inflation risk and distorting the portfolio choices of agents on the other. We argue that the optimal haircut is higher when the central bank is unable to lend exclusively to agents who actually need liquidity. Finally, for an unexpected drop in the haircut, the central bank can be more aggressive than when setting a permanent level of the haircut.
Keywords: Payment clearing and settlement systems; Central bank research; Monetary policy implementation; Financial system regulation and policies; Financial services (search for similar items in EconPapers)
JEL-codes: E40 E50 (search for similar items in EconPapers)
Pages: 44 pages
New Economics Papers: this item is included in nep-ban, nep-cba, nep-mac, nep-mon and nep-reg
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Journal Article: Central bank haircut policy (2011)
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Persistent link: https://EconPapers.repec.org/RePEc:bca:bocawp:10-23
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