New method estimates time-varying liquidity elasticity of euro rates
The European Central Bank has introduced a new method to estimate the time-varying elasticity of euro money market rates to excess liquidity. This approach, adapted from the Federal Reserve Bank of New York, is applied to both the euro short-term rate (€STR) and euro general collateral repo rates.
Unpacking the Reserve Demand Curve
Understanding the demand for central bank reserves is crucial for effective monetary policy implementation.
The relationship between reserves and money market rates is non-linear, typically flat at low or high reserve levels and downward-sloping at intermediate quantities.
This box introduces a new, real-time method to estimate the time-varying elasticity of euro money market rates to excess liquidity, adapted from the Federal Reserve Bank of New York (FRBNY) for both the euro short-term rate (€STR) and euro general collateral repo rates.
The methodology addresses significant challenges, including the endogeneity between liquidity price and volume, and the horizontal or vertical shifts in the demand curve over time.
For instance, during the euro area sovereign debt crisis, precautionary reserve demand increased, shifting the curve rightward, while more recent shifts reflect changes in non-bank deposits.
Collateral Scarcity and Global Divergence
The euro area currently shows limited rate sensitivity to liquidity conditions.
Unsecured market rates became largely insensitive to fluctuations after 2008, with temporary negative elasticity only during 2013/14 and the COVID-19 pandemic.
In contrast, repo rates have shown more reactivity, mirroring global trends.
Their sensitivity strengthened during liquidity growth and weakened during balance sheet reductions, indicating a collateral scarcity channel where Eurosystem asset purchases constrain collateral availability.
This contrasts with recent developments in the United States and the United Kingdom, where officials linked upward moves in secured money market rates to diminishing reserve supply, leading to policy adjustments.
A Timely Tool for Shifting Landscapes
The new methodology offers crucial real-time insights into the complex dynamics of euro area money markets, moving beyond static models.
Its findings underscore the importance of distinguishing between secured and unsecured segments, especially given the evolving role of collateral scarcity.
This enhanced analytical capacity is vital for central banks to navigate increasingly divergent global liquidity environments and refine their operational frameworks.