Geen diatitel

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Basic concepts of Eurosystems Operational
Monetary Policy Framework and Experiences with
the operational framework Hans Pijl Division
Financial Markets Department Treasury and
Monitoring
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Basic concepts of Eurosystems Operational
Monetary Policy Framework
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• Monetary policy strategy
• Why central banks?
• What targets have central banks?
• Why to fight inflation?
• Monetary policy implementation
• How to implement these strategies?
• Role and functions of official interest rates?
• How can a central bank generate stable
  interest
• rate movements?

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• Monetary policy strategy
• The monetary strategy determines which money
• market interest rate level is required to
  maintain
• price stability.
• Monetary policy implementation
• The operational framework determines how to
• achieve this interest rate level using the
  available
• monetary instruments.

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Transmission of monetary policy and instruments
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• Functions of the operational framework
• Eurosystem sets and stabilises interest rates in
• the short term money market in two ways
• Signalling its monetary policy stance to the
  money
• market
• Managing the liquidity situation in the money
• market

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How to set (money market) interest rates? Step
1 determine official interest rates Step 2
make banks dependent on credit by the ECB Step
3 extend credit to banks with the appropriate
interest rate Step 4 design framework to
stabilise very short-term interest rates
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• Main monetary policy instruments
• Minimum reserve requirements
• Credit extension to banks via
• Open Market Operations
• Main refinancing operations
• Long-term refinancing operations
• Fine-tuning operations
• Structural operations
• Standing facilities
• Marginal lending facility
• Deposit facility

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• Minimum reserve requirements
• During a reserve maintenance period banks have on
  average to maintain a certain percentage of
  certain banks balance sheet items (2) on an
  account at the central banks
• Create / increase money market shortage
• (counterparties vis a vis Eurosystem)
• Averaging feature helps stabilising overnight and
• intraday money market rates

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• Minimum reserve requirements
• Interest paid over required reserves
• Excess reserves not remunerated, giving incentive
  
• to go to the market
• Penalty in case of non-compliance
• Banks with large payment flows prefer large
• reserve requirements

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• Open marktoperations
• Main refinancing operations (MROs)
• about 70 of total credit extension
• Long term refinancing transactions (LTROs)
• about 30 of total credit extension
• Fine-tuning operations (FTOs)
• nowadays last day of the reserve maintenance
• period
• Structural operations

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• Main refinancing operations (MROs)
• Liquidity providing
• Conducted on a weekly basis
• One week maturity
• Reverse transactions

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• Main refinancing operations (MROs)
• Open for all banks with a minimum reserve
• requirement (cf US system of primary dealers)
• Interest rate on MROs is main ECB interest rate
• Main source credit extension Eurosystem
• Variable rate tender (opposite to fixed rate
  tender)
• Marginal rate few base points above min. bidrate

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• Long term refinancing transactions (LTROs)
• Liquidity providing
• Monthly auction via variable rate tender
• Three month maturity

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• Long term refinancing transactions (LTROs)
• Reverse transactions
• Pre-announced 50 billion euro size each
• Particularly designed for smaller banks
• Amount allotted is sufficient to balance supply
  and demand

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• Fine-tuning operations (FTOs)
• Smooth out effects on interest rates of
  unexpected
• liquidity fluctuations
• Liquidity providing or liquidity absorbing
• Ad hoc basis and regular basis i.e. last day of a
  reserve maintenance period

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• Fine-tuning operations (FTOs)
• Short-term basis
• Tender or bilateral operation
• Selected group of fine-tuning counterparties

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• Structural operations
• Liquidity-providing or liquidity-absorbing
• Conducted on an ad hoc basis (never used yet)
• Maturity not standardised
• Tender or bilateral operations

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• Types of open market operations
• Reverse transactions
• Outright transactions
• Foreign exchange swaps
• Collection of fixed-term deposits
• Issuance of ECB debt certificates

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• Stabilizing money market interest rates
• Fine-tuning instruments
• Averaging facility on the reserve requirements
• Standing facilities

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Standing facilities Deposit facility
overnight liquidity absorption at relatively
low (official) interest rate floor for market
rates normally no restrictions Marginal
lending facility overnight liquidity provision
at relatively high (official) interest rate
ceiling for market rates normally no
restrictions except collateral
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• Standing facilities
• General
• Providing / absorbing liquidity at the discretion
  of
• banks/at the initiative of counterparties
• Limiting maximum interest volatility
• Signal general stance of monetary policy

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• Standing facilities
• Usage only at the end of the maintenance period
• Occasionally large resource on deposit facility
  due
• to securities settlement

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Liquiditeitsmanagement Eurosysteem

• Demand
• - Reserve requirements
• - Excess reserves
• - Autonomous factors
• factors (net)
• - deposit facility

• Supply
• Open market operations
• MROs (policy rate)
• LTROs
• Fine tuning
• Structural operations
• marginal lending facility

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Liquiditeitsmanagement Eurosysteem

• Demand
• - Reserve requirements
• - Excess reserves
• - Autonomous factors
• factors (net)
• - deposit facility

• Supply
• Open market operations
• MROs (policy rate)
• LTROs
• Fine tuning
• Structural operations
• marginal lending facility

(over a reserve maintenance period)
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When is implementation succesfull? Stable and
small spread between minimum bid rate and EONIA
rate
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Central Bank Balance Sheet
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• Principles
• Operational efficiency
• Open market economy / hands-off approach
• Equal treatment of counterparties
• Decentralisation op implementation, simplicity,
  transparency, continuity, safety and cost
  efficiency

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Experiences with the operational framework
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• Issues
• Modification of Operational Framework in March
  2004
• Transparency of allotment policy
• Volatility Treasury Deposit
• End of period fine-tuning operations
• EONIA Swaps
• Optimal size and composition open market
  operations
• Future challenges

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• I Modification of Operational
  Framework in March 2004
• Several problems encountered
• Interest rate changes during a maintenance
  period
• Underbidding in tenders, because of interest
  rate expectations and overlapping tenders
• Weekend problem in minimum reserves and use of
  standing facilities

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• I Modification of Operational
  Framework in March 2004
• Solution
• Changing maintenance period from Monetary
• Council meeting to the next Monetary council.
• Shortening the duration of the MROs to one week

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• II Transparency of allotment policy
• Till March 2004 only publication of forecast for
  
• autonomous factors
• Sometimes wrong interpretation of allotment by
  the market
• New information about autonomous factors and
• excess reserves by daily update ECB LM figures
• From March 2004 publication of Benchmark
• allotment, before and after allotment
• Nowadays frontloading (more than benchmark
• allotment) as lubricant to buffer micro-economic
• frictions in the money market.

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• III Volatility Treasury Deposit
• Large swings in treasury deposits hampered
• efficient liquidity management by ECB
• Measures to limit volatility
• Remuneration
• Arrangements (Italy)

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• IV End of period fine-tuning
• operations
• In new framework accumulation of autonomous
• factors forecasts more pressing
• Nowadays standard end-of-period FTO
• Liquidity providing operations are more popular
  than liquidity absorbing operations
• Reason timing of operation, interest rate
  operation, different specification

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• V EONIA Swaps
• Interest rate swaps
• from 1 week to 12 months
• used for
• hedging interest rate risk (transform fixed
  debt into variable or reverse)
• arbitrage
• taking positions on the curve
• EONIA swap market is a very large market
• Sometimes spill-overs on operational target/Cash
• market

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• EONIA swap hedge example (1)
• Credit to customer for 12 months at 3.5
• Does not want to fund for 12 months, but want to
  hedge interest rate risk
• Solution a 12 months EONIA (payer)swap at 2.26
• pay the fix (2.26) and receive the floating
  (EONIA)
• fund daily in the overnight market and pay the
  EONIA (or less)
• Difference is calculated daily (compounding) and
  settled at the end of the period

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• EONIA swap hedge example (2)
• Issue 12 month paper to cover deficit
• Does not want the 12 month interest rate exposure
• So conclude a 12 months EONIA (receiver)swap at
  2.24
• receive the fix (2.24) and pay EONIA

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VI. Optimal size and composition open market
operations
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• VI. Optimal size and composition open
• market operations
• Implications for monetary policy implementation?
• Not convinced that current situation requires
• substantial changes
• Substantial reduction of reserve ratio
• Maybe more reverse LTROs or structural
  operations
• No monetary policy outright portfolio

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• VII Future challenges
• the management of the volatility of short term
  interest rates
• determining the optimal size and composition of
  central bank balance sheet
• the appropriate level of communication with the
  financial markets
• contribute to further integration of financial
  markets by harmonising and expanding collateral
  instruments

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Questions ?
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Hans Pijl Division Financial Markets Department
Treasury and Monitoring h.h.t.pijl_at_dnb.nl Phone
number 00 31 20 524 2214