The first chapter of this dissertation investigates the implications of a change in lending policy of the Federal Reserve in the US on money market rates. In January 2003, the Federal Reserve replaced the discount window with the primary credit facility as the mechanism for depository institutions to borrow short-term funds. This system now allows approved institutions to borrow freely at a rate higher than short-term money market rates. It is shown that the Federal Reserve has effectively granted a series of free perpetual American options to market participants, with the strike rate being the primary credit rate. This interpretation allows us to explain certain stylized changes in the properties of interest rates, including the subsequent decrease in volatility. The exercise of these options, i.e. borrowing at the primary credit facility, is highly correlated with the moneyness of these options.
Several countries use standing facilities (both lending and deposit facilities) as an important mechanism to implement monetary policy. The effect of the introduction of a lending facility on interest rates in the US has been explored in the first chapter. This paper examines monetary policy in three countries—pre-European Union Germany, Canada and the United Kingdom. Canada introduced lending and deposit facilities simultaneously, whereas the other two countries either introduced or changed the operating features of one of the facilities as part of changes in their monetary policy implementation. The resulting variation in institutional settings provides a rich laboratory for examining the relationship between standing facilities and market interest rates. In all these three cases, it can be seen very clearly that the presence of these facilities inhibits extreme movements of the money market rates and thereby curbs interest rate volatility.
|School Location:||United States -- New York|
|Source:||DAI-A 69/01, Dissertation Abstracts International|
|Keywords:||Central bank, Interest rates, Lending facilities, Money market, Standing facilities|
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