Floor systems for implementing monetary policy: Some unpleasant fiscal arithmetic

Abstract

An increasing number of central banks implement monetary policy via a channel system or a floor system. We construct a general equilibrium model to study the properties of these systems. We find that a floor system is weakly optimal if and only if the target rate satisfies the Friedman rule. Unfortunately, the optimal floor system requires either transfers from the fiscal authority to the central bank or a reduction in seigniorage payments from the central bank to the government. This is the unpleasant fiscal arithmetic of a floor system. When the central bank faces financing constraints on its interest expense, we show that it is strictly optimal to operate a channel system.

Voluntary Reserve Targets

“…A different literature, however, highlights the potential for the choice of monetary policy implementation framework to affect macroeconomic variables in unexpected ways. These include Berentsen and Monnet (), Ennis and Keister (), Berentsen, Marchesiani, and Waller (), Keister, Martin, and McAndrews (), and Williamson ().…”

“…Indeed, if the liquidity premium on reserves were sufficiently high, this substitution of reserves for longer dated debt might prove profitable. But where this mechanism is misunderstood or underappreciated, or it is deemed unpalatable for the monetary authority to manipulate the maturity structure of government liabilities, there might exist political or other forces which implicitly limit a central bank's interest payments (Berentsen, Marchesiani, and Waller ).…”

The Impact of Return on Collateral in a Channel System

“…The nature of floor system may contribute to the different behavior of money market in Norway than in other countries. As Berentsen, Marchesiani, and Waller () have shown, in order to run the floor system optimally, it is necessary for the central bank to generate a positive income either by holding a large number of real assets (typically government bonds) or by receiving transfers from fiscal authority . Given that it is more likely that the central bank holds real assets rather than receiving transfers, the central bank's activity affects the bond market, and thus, the price of collateral.…”

“…Berentsen and Monnet () build the first general equilibrium model to analyze the optimal interest‐rate corridor in a channel system. Subsequent papers built on Berentsen and Monnet's model to provide theoretical analysis on various features of a channel system are Martin and Monnet (), Chapman, Chiu, and Molico (), Berentsen, Marchesiani, and Waller (), and Keister, Martin, and McAndrews () among others.…”

Liquidity in the repo market

“…Thus, the SNB operated a so-called corridor system and steered money market interest rates via the conditions offered in open market operations (see, e.g. Jordan and Kugler (2004) and Berentsen, Marchesiani and Waller (2014)).…”