Norges Bank's system for managing interest rates.

• Author: Kran, Lars-Christian
• Position: Norway

The article provides an account of Norges Bank's practical implementation of monetary policy in the money market through liquidity policy. Liquidity policy consists of Norges Bank's operations in the money market to influence the banking system's liquidity. Liquidity policy shall be consistent with the interest rate signals given by Norges Bank through monetary policy, and ensure that changes in the key rates have a broad impact on short-term money market rates. Liquidity policy shall also facilitate efficient execution of banks' payment settlements in the central bank. Liquidity operations shall not have an effect on money market rates that may result in a lack of clarity regarding Norges Bank's interest rate signals.

Main features of liquidity policy in Norway

All banks established in Norway may have deposit accounts in Norges Bank. The liquidity of the banking system is banks' aggregate sight deposits in accounts in Norges Bank from one business day to the next. The banking system's structural liquidity is banks' sight deposits with Norges Bank as they would have been without the Bank supplying or withdrawing liquidity by means of liquidity instruments. In the course of a year, banks' structural liquidity varies between substantial borrowing needs and substantial deposits in Norges Bank (see Chart 1).

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Structural liquidity is influenced by a number of autonomous factors. The central government has its NOK account in Norges Bank. This means that payments in NOK to and from the central government, including central government loan transactions (but not payments between the central government and Norges Bank) directly influence banks' liquidity. There is often considerable uncertainty regarding the net liquidity effect of central government incoming and outgoing payments from day to day. Norges Banks' transactions in the foreign exchange market and government securities market and changes in volumes of notes and coins in circulation also influence banks' liquidity.

In some periods, the central government has issued Treasury bills to reduce structural surplus liquidity. Apart from this, no special measures have been implemented to influence banks' structural liquidity situation.

By providing and absorbing liquidity by means of fixed-rate loans and deposits (see separate box for definition), Norges Bank ensures that at the end of each day the banking system has sight deposits of the order of NOK 5-12 billion in Norges Bank. Chart 2 shows structural liquidity and sight deposits after Norges Bank's liquidity operations in June 2000. Norges Bank supplied liquidity in the form of fixed-rate loans in the period 5-21 June and withdrew liquidity in the form of fixed-rate deposits from 27 June to the beginning of July. Auctions of fixedrate loans and deposits contribute to making the use of the standing facilities (sight deposits and overnight loans) independent of structural liquidity (see Chart 2). Liquidity policy contributes to ensuring that money market rates are normally only slightly higher than the deposit rate and makes them independent of banks' structural liquidity (see Chart 3, which shows money market rates in 1999 and 2000). The high tomorrow/next rate after the end of 2000 shown in the chart is due to special conditions in the interbank market.

Some key concepts

* The key rate: the interest rate the central bank wishes to have a broad impact on short money market rates.

* Standing facility: lending and deposit facility available in a central bank. Can be used by banks on their own initiative.

* Deposit rate: Interest rate on intraday deposits in Norges Bank. The deposit rate is Norges Bank's key rate, and forms the floor for short money market rates.

* Overnight lending rate: Interest rate on overnight loans from Norges Bank.

* Fixed-rate loans: Loans (against collateral in the form of securities) at a fixed interest rate and with a given maturity. The interest rate on fixed-rate loans is normally fixed through multi-price auction. The maturity of fixed-rate loans varies and depends on the liquidity situation.

* Fixed-rate deposits: Deposits at a fixed interest rate and with a given maturity. The interest rate on fixed-rate deposits is normally fixed through multi-price auction. The maturity of fixed-rate deposits varies and depends on the liquidity situation.

* Repurchase agreements (repos): Agreements on sale and repurchase of securities at preagreed prices.

* Currency swaps: Exchange of NOK for foreign currency for an agreed period.

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Norges Bank's Executive Board sets the interest rates on the Bank's automatic deposit and lending facilities, which normally form a corridor for the shortest money-market rates. Interest rates on Norges Bank's fixed-rate loans and deposits are normally established in the market through multi-price auction. Because Norges Bank ensures that the banking system has aggregate deposits in Norges Bank, the deposit rate is banks' marginal investment rate. The deposit rate is thus Norges Bank's key rate. The overnight lending rate has limited monetary policy significance. The interest rate on Norges Bank's market operations...