DP2605 A Model of the Open Market Operations of the European Central Bank

Author(s): Juan Ayuso, Rafael Repullo
Publication Date: November 2000
Keyword(s): European Central Bank, Monetary Auctions, Monetary Policy Instruments, Open Market Operations, Tender Procedures
JEL(s): D44, E52, E58
Programme Areas: International Macroeconomics, Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=2605

We construct a model to analyse the two types of tender procedures used by the European Central Bank (ECB) in its open market operations. We assume that the ECB minimizes the expected value of a loss function that depends on the quadratic difference between the interbank rate and a target interest rate that characterizes the stance of monetary policy. We show that when the loss function penalizes more heavily interbank rates below the target, fixed rate tenders have a unique equilibrium characterized by extreme overbidding. We also show that variable rate tenders have multiple equilibria characterized by varying degrees of overbidding, and that in these tenders an equilibrium without overbidding can be obtained by preannouncing the intended liquidity injection. Finally, our empirical analysis supports the assumption of an asymmetric loss function for the ECB.