Monetary Policy Transmission in Segmented Markets

Abstract

This paper studies two frictions that impede the effective pass-through of monetary policy in the European repo market. Collateral scarcity creates a wedge between the ECB's Deposit Facility Rate and inter-dealer repo rates. Dealer market power causes inter-dealer repo rates to pass through imperfectly to customer-facing OTC repo rates. Using a dataset covering both inter-dealer and OTC repo trades, we provide empirical evidence consistent with dealer market power in the OTC repo market. We build a model to illustrate how collateral scarcity and market power create interacting frictions in repo markets, and we verify its predictions using the September 2019 monetary policy rate cut. The model implies that policies that alleviate dealer market power, such as customer access to centralized trading and customer-facing secured funding facilities like the Federal Reserve's RRP, can alleviate dealer market power and improve the pass-through of monetary policy.

Keywords: monetary policy, pass-through efficiency, repo market, market power

JEL Classification: G20, G21, E50