The Minimum Liquidity Deficit and the Maturity Structure of Central Banks' Open Market Operations: Lessons from the Financial Crisis

31 Pages Posted: 4 Jan 2011

See all articles by Jens Eisenschmidt

Jens Eisenschmidt

European Central Bank (ECB)

Cornelia Holthausen

European Central Bank (ECB); Centre for Economic Policy Research (CEPR)

Date Written: December 16, 2010

Abstract

This paper studies the relationship between the size of the banking sector’s refinancing needs vis-à-vis the central bank and auction rates in its open market operations in times of financial market stress. In a theoretical model, it is found that marginal rates at central bank auctions may increase if the share of troubled banks becomes too high relative to the total size of the banking sector’s refinancing needs. An empirical analysis then aims at determining the size of open market operations needed to absorb large stress levels in interbank money markets and hence contain central bank auction rates. Finally, the paper analyses effects of the composition of open market operations of different maturities on auction rates. It is found that a too high share of longer-term refinancing induces a rise in auction rates which is undesirable. Therefore, the analysis suggests that there is a lower bound for the amount of liquidity provided through short-term operations.

Keywords: central bank, money market, open market operations, financial crisis

JEL Classification: G01, G10, G21

Suggested Citation

Eisenschmidt, Jens and Holthausen, Cornelia, The Minimum Liquidity Deficit and the Maturity Structure of Central Banks' Open Market Operations: Lessons from the Financial Crisis (December 16, 2010). ECB Working Paper No. 1282, Available at SSRN: https://ssrn.com/abstract=1726339

Jens Eisenschmidt (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Cornelia Holthausen

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
+49 69 1344 6490 (Phone)
+49 69 1344 855 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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