FRM Part II · FRM Exam Part II · Monetary and Fiscal Policy: Safeguarding Stability and Trust
A central bank sets a policy corridor with a deposit facility rate of 3.50% and a marginal lending facility rate of 4.50%. The policy rate is set at the midpoint. Interbank overnight rates are currently trading at 4.45% because of a temporary liquidity shortage. Which action by the central bank is most consistent with returning the overnight rate toward the policy rate?
Providing liquidity to the system is the consistent action. The policy rate is the 4.00% midpoint, and an overnight rate of 4.45% near the ceiling signals scarce reserves. Adding reserves eases the shortage and pulls rates down, while restricting liquidity or raising the ceiling would push rates higher.
- ALower the deposit facility rate to 3.00%
- BConduct liquidity-providing operations to add reserves to the systemCorrect
- CRaise the marginal lending facility rate to 5.00%
- DReduce the allotment of liquidity in its regular auctions
Explanation
The midpoint policy rate is 4.00%. Market rates near the ceiling of 4.45% signal scarce reserves. Supplying liquidity through operations eases the shortage and pulls rates down toward the midpoint. Raising the ceiling or cutting allotments would push rates higher, and lowering the floor does not address the shortage at the top of the corridor.
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