IMF Working Papers

The ECB’s Future Monetary Policy Operational Framework: Corridor or Floor?

By Luis Brandão-Marques, Lev Ratnovski

March 15, 2024

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Luis Brandão-Marques, and Lev Ratnovski. The ECB’s Future Monetary Policy Operational Framework: Corridor or Floor?, (USA: International Monetary Fund, 2024) accessed February 9, 2025

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

This paper reviews the trade-offs involved in the choice of the ECB’s monetary policy operational framework. As long as the ECB’s supply of reserves remains well in excess of the banks’ demand, the ECB will likely continue to employ a floor system for implementing the target interest rate in money markets. Once the supply of reserves declines and approaches the steep part of the reserves demand function, the ECB will face a choice between a corridor system and some variant of a floor system. There are distinct pros and cons associated with each option. A corridor would be consistent with a smaller ECB balance sheet size, encourage banks to manage their liquidity buffers more tightly, and facilitate greater activity in the interbank market. But it would require relatively more frequent market operations to ensure the money markets rate stays close to the policy rate and could leave the banking system vulnerable to intermittent liquidity shortages that may have financial stability implications and impair monetary transmission. The floor, on the other hand, would allow for more precise control of the overnight rate and a lower risk of liquidity shortages, but it would entail a somewhat larger ECB balance sheet, weaken the incentives for banks to manage their liquidity buffers, and discourage interbank market activity. The analysis of tradeoffs suggests that, on balance, in steady state, a hybrid system that combines the features of the “parsimonious floor” (with a minimal volume of reserves) with a lending facility or frequent short-term full-allotment lending operations priced at or very close to the deposit rate, making it a “zero (or near-zero) corridor”, would be most conducive for achieving the ECB’s monetary policy objective.

Subject: Asset and liability management, Central bank policy rate, Financial markets, Financial services, Interbank markets, Liquidity, Monetary policy, Money markets, Standing facilities

Keywords: Central bank operations, Central bank policy rate, ECB balance sheet, ECB's monetary policy objective, ECB's supply, Global, Interbank markets, Liquidity, Liquidity shortage, Monetary policy, Money markets, Standing facilities, Supply of reserve, The ECB

Publication Details

  • Pages:

    40

  • Volume:

    ---

  • DOI:

    ---

  • Issue:

    ---

  • Series:

    Working Paper No. 2024/056

  • Stock No:

    WPIEA2024056

  • ISBN:

    9798400266973

  • ISSN:

    1018-5941