A model of the Eurosystem's operational framework and the euro overnight interbank market

- We model an overnight interbank money market with frictions.
- The model explicitly accounts for the main institutional features of the euro area.
- We explain the main developments of interbank markets during the financial crisis.
- We discuss policy implications for the Eurosystem.

This paper develops a theoretical model which replicates main institutional features of the euro overnight interbank market and the Eurosystem's operational framework which has been in place since September 2008. Main ingredients of the model are frictions in the form of participation costs in the interbank market, a refinancing operation with unlimited liquidity supply and two standing facilities offered by the central bank. The model can explain several stylized facts observed during the financial crisis as the decline in interbank borrowing and the interbank rate, the increased borrowing from the Eurosystem and the strong recourse to its deposit facility. Furthermore, we discuss some policy implications.