Relationship Between Short-Term Interest Rates and Excess Reserves: A Logistic Approach
IMF Working Papers, April 6, 2018
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- Relationship Between Short-Term Interest Rates and Excess Reserves: A Logistic Approach
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Bibliographic details
- Authors: Romain M Veyrune, Guido della Valle, Shaoyu Guo
- Published: April 6, 2018
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781484350690.001
Overview and objective
- Models the relationship between short-term rates and excess reserves in an interest rate corridor as a logistic function estimated for the Eurosystem.
- Estimates are used to identify conditions in which short-term rates become unanchored, i.e., move away from policy rates and become more volatile within the interest rate corridor defined by the interest rates of the central bank’s standing facilities.
- Paper authors: Romain M Veyrune, Guido della Valle, Shaoyu Guo.
- Publication date: April 6, 2018.
Main findings and diagnostics
- Short-term rate “un-anchoring” occurs when short-term rates move away from policy rates and become more volatile within the central bank’s interest rate corridor.
- The conditions leading to un-anchoring are attributed to coordination failures among counterparties at open market operations under fixed-rate and full-allotment procedures in the context of segmented markets.
- A model of segmented markets describes how un-anchoring takes place when counterparties pursue bidding strategies that are:
- Optimal from an individual perspective; and
- Sub-optimal from an aggregate perspective.
Model and analytical approach
- Relationship between short-term rates and excess reserves is specified as a logistic function and estimated for the Eurosystem.
- The model focuses on the mechanics of an interest rate corridor set by the interest rates of the central bank’s standing facilities and the behavior of counterparties in open market operations under fixed-rate, full-allotment procedures.
- Emphasis on market segmentation and strategic bidding behavior as mechanisms producing deviations from policy rates.
Policy-relevant implications (from the analysis)
- Identification of conditions under which short-term rates become un-anchored provides diagnostics for central banks operating an interest rate corridor.
- Coordination failures among counterparties in open market operations and market segmentation are central to episodes of un-anchoring, implying that central banks should monitor:
- The functioning and incentives of counterparties in fixed-rate, full-allotment operations;
- Indicators of market segmentation that may exacerbate strategic bidding behavior leading to volatility within the corridor.