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Jorgen Elmeskov OECD

Reserve Bank of India Research Conference 2010 Session I: Credit Freeze, Dysfunctional Markets and Monetary Policy Transmission Uncertainty / Policy Options for the Central Banks - discussion. Jorgen Elmeskov OECD. Two observations on feasibility. It is feasible...

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Jorgen Elmeskov OECD

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  1. Reserve Bank of India Research Conference 2010Session I: Credit Freeze, Dysfunctional Markets and Monetary Policy Transmission Uncertainty / Policy Options for the Central Banks- discussion Jorgen Elmeskov OECD

  2. Two observations on feasibility • It is feasible... • ...to set interest rates independently of the quantity of liquidity... • ...and to influence asset prices through the composition of central bank assets... • ...but it may also raise a number of problems • ...that will have to be addressed in the context of exit

  3. 1. Decoupling of interest rates and liquidity • Raising interest rates when excess reserves are large will require hikes in the interest rate on deposits which tends to become the main determinant of overnight rates • This will again tend to suppress activity in the money market • And leaving in place large amounts of excess reserves increases the risk that they will spill over into money and credit • These effects suggest that liquidity should be mopped up as financial sector conditions improve

  4. 1. Decoupling of interest rates and liquidity • Mopping up should be more or less automatic as temporary extensions of traditional liquidity instruments are reversed • Though three footnotes apply to the reversal of such schemes • It may be desirable to leave some extensions in place • In the near term price-based discouragement of use may be preferable to discontinuation • There may be a need to smooth liquidity • Where liquidity has been boosted by purchasing long-dated assets mopping up will require action • Selling back assets may not be simple • So other instruments may have to be used • Long-term deposits, reverse repos, issuance of central bank bills

  5. 2. Effects of central bank asset holdings • Some central banks have bought large amounts of long-dated assets • They expose the central bank to interest rate and, at least in principle, credit risk • And continued holding of these assets may lead to economic distortions • But selling back assets may not be so simple • Political pressure could arise • Substantial losses could be realised which could be politically awkward and might dent credibility

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