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The role of collateral requirements in the crisis: one tool for two objectives?

Paolo Fegatelli ()

No 44, BCL working papers from Central Bank of Luxembourg

Abstract: The implications of central bank collateral requirements for the monetary policy transmission mechanism and the working of the money market have often been neglected. Such implications, however, have clearly manifested during the course of the 2007-2009 crisis. As liquidity was vanishing in the interbank market, banks used (and abused of) central bank funding more intensively, in order to cover their financing needs. As a result, central bank collateral eligibility criteria have become even more critical than the policy rate as a factor of monetary policy transmission as well as a driver of liquidity in the interbank market. Thus, in the light of a retrospective analysis of some major events affecting monetary policy in the Euro area in the last two years, this study intends to properly reformulate the problem related to the choice of ?optimal? collateral requirements, by illustrating their interrelations with other central bank policy tools and targets. Ultimately, this approach allows us to derive a non-exhaustive set of recommendations for collateral and interest rate policies, as well as for central banks? exit strategies from the current unconventional measures.

Keywords: Collateral; Monetary policy; Central bank; Interbank market; Financial stability (search for similar items in EconPapers)
JEL-codes: E58 E51 E52 (search for similar items in EconPapers)
Date: 2010-02
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