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A critique of the ECB's liquidity policies | 66 comments (66 topical, editorial, 0 hidden)
Re: A critique of the ECB's liquidity policies (4.00 / 3)
There's a similar stable heartbeat pattern in mid-decade, presumably between higher upper and lower bounds?

As my data set doesn't extend back beyond 2004, I plot only from then.

The plateau in the middle of the chart with the ECB rates at 3-4-5% corresponds to the initial period of the crisis. The ECB raised rates by 0.25% on June 13, 2007, a week before Bear Stearns kicked off the financial crisis by closing its subprime hedge funds. Then the ECB was in a wait-and-see mode until March (around the time that Bear Stearns finally failed). You can see EONIA is rather chaotic during that period.

The other major qualitative feature of the chart is that prior to the Lehman failure interbank rates hovered above the main refinancing rate. However, since 15 october, 2008 (the start of the steep downward rate movement from the peak) the ECB MRO has been on "fixed rate, unlimited tender", which has allowed the banks to hoard cash and has dropped the interbank baseline to the deposit rate.

The fact that the baseline of interbank rates remains close to the deposit rate would seem to indicate that the banks are still hoarding cash. However, the ECB has been withdrawing liquidity from the system. The MRO is still "unlimited tender" but other "liquidity support" (in the form of unlimited auctions at maturities longer than a week) is being withdrawn. Here I have argued that the "bond sterilization" is, in fact, withdrawing liquidity too.

So, banks are hoarding cash but spare liquidity is very tight. This might explain the growing instability in EONIA. It might be a sign of very unequal states of health among European banks.

Looking into this I found the following from last September (with my emphasis):

But the two-pronged approach, while messy, could work. If unlimited cash was available only in one-week rather than three-month portions by then, the ECB would still get the normal impact from a rate hike.

"If you wanted to continue providing unlimited liquidity while raising interest rates, the system in Europe would in many ways facilitate that quite easily," said Societe Generale economist James Nixon.

"The impact of a 25 basis point hike would be exactly the same. It would just mean that overnight rates, instead of being centred around the ECB's main refinancing rate, would sit at a small margin to the deposit rate." The ECB's deposit rate is currently 0.25 percent, while the benchmark is 1 percent.

That could all change, though, if the health of vulnerable banks suddenly improved. Excess cash in the system would soon disappear as banks sucked it up, driving market rates the 75 basis points towards the refinancing rate.

Such a move, although likely to take time, would be bigger than any single interest rate hike in the ECB's history, and all without the ECB's finger going near the interest rate trigger.

(Reuters: Bank aid may be no barrier to ECB rate hikes, September 23, 2010)

By "suck up excess cash" Nixon doesn't mean "hoard" (which is what they're doing as the vulnerable banks are unhealthy) but actually "use".

Keynesianism is intellectually hard, as evidenced by the inability of many trained economists to get it - Paul Krugman

by Carrie (migeru at eurotrib dot com) on Fri Feb 25th, 2011 at 02:24:10 AM EST
[ Parent ]
Re: A critique of the ECB's liquidity policies (none / 0)
So the recent more prolonged spikes, taking EONIA above the refinancing rate a couple of times, could be the result of healthier banks looking for liquidity to use (ie lend and therefore inject into the economy), and having difficulty finding it because the ECB is tightening by sterilising bond purchases?
by afew (afew(a in a circle)eurotrib_dot_com) on Fri Feb 25th, 2011 at 04:40:37 AM EST
[ Parent ]
Re: A critique of the ECB's liquidity policies (4.00 / 3)
I'd say it's more about unhealthy banks scrambling for liquidity.

EONIA, unlike the ECB's MRO or MLF, doesn't require the posting of collateral.

So a bank all of whose clean assets are already pledged at the MRO needs to look at the unsecured interbank market. If they are paying more for Eonia than they would pay for 3-month Euribor it means the Euribor is closed to them.

A key difference between Eonia and Euribor is that Euribor is an offered rate whereas Eonia is the average rate at which actual overnight lending took place.

Keynesianism is intellectually hard, as evidenced by the inability of many trained economists to get it - Paul Krugman

by Carrie (migeru at eurotrib dot com) on Fri Feb 25th, 2011 at 04:54:01 AM EST
[ Parent ]
Re: A critique of the ECB's liquidity policies (4.00 / 2)
OK, got it. A little more reaches the light of day (mine, anyway) with each post.

Maieutics.

by afew (afew(a in a circle)eurotrib_dot_com) on Fri Feb 25th, 2011 at 05:01:46 AM EST
[ Parent ]
Maieutics (none / 1)
For me, too.

I understand a lot more now than a week ago, when I fired off the first inchoate version of my argument.

Appropriately, now I know more about how much I don't know. At least I have located a bunch of data I have yet to examine.

Keynesianism is intellectually hard, as evidenced by the inability of many trained economists to get it - Paul Krugman

by Carrie (migeru at eurotrib dot com) on Fri Feb 25th, 2011 at 05:24:37 AM EST
[ Parent ]
Known unknowns, huh? (none / 1)
(channelling Unca Donald)

It is rightly acknowledged that people of faith have no monopoly of virtue - Queen Elizabeth II
by eurogreen on Fri Feb 25th, 2011 at 10:08:37 AM EST
[ Parent ]
Re: A critique of the ECB's liquidity policies (none / 1)
And a spike about once a month. Interesting. Audits or reports of some kind? Liquidity-stress from real economy (pay-day or something)?

Banking practise details needed here, I suspect.

Sweden's finest (and perhaps only) collaborative, leftist e-newspaper Synapze.se

by A swedish kind of death on Fri Feb 25th, 2011 at 06:38:05 AM EST
[ Parent ]
Re: A critique of the ECB's liquidity policies (4.00 / 2)
Migeru:
the maintenance periods are likely responsible for the heartbeat pattern
I have not yet attempted to correlate the ECB's reserve maintenance calendar with the spikes.

Keynesianism is intellectually hard, as evidenced by the inability of many trained economists to get it - Paul Krugman
by Carrie (migeru at eurotrib dot com) on Fri Feb 25th, 2011 at 06:43:44 AM EST
[ Parent ]

A critique of the ECB's liquidity policies | 66 comments (66 topical, 0 editorial, 0 hidden)
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