Essays on the implementation of monetary policy

Chapter 1 builds a two-bank bargaining model of the overnight interbank market in which, due to the commitment of the central bank to its interest rate target, bargaining between banks impacts loan sizes rather than interest rates (the converse of existing models). As a result, policy changes have a different impact to what is posited by existing models. The model is applied to a market where the commitment of the central bank is well documented (Australia). With reasonable parameter values, the model replicates five stylised facts of the Australian market. Moreover, the stylised facts are replicated without recourse to any asymmetries. Chapter 2 extends the two-bank model to incorporate a large number of heterogeneous banks. This model is able to replicate the asymmetric shape of banks' end-of-day central bank deposit distributions (despite symmetric initial distributions); a novel contribution to the literature. Moreover, after inputting recent changes in Australian central bank policy, this model produces percentage changes in interbank trading volumes that closely align with the data. Central banks typically supply more overnight deposits than banks desire to hold (in aggregate), but this aggregate is typically small relative to interbank lending. With commitment, this is not required for the central bank to achieve its interest rate target (the typical explanation in the literature). So, to explain this phenomenon, Chapter 3 builds a DSGE model that incorporates commitment and the results from the previous chapters. Due to asymmetric information, there may be stigma associated with borrowing from the central bank's overnight lending facility, which is costly. But while the central bank can reduce use of its lending facility, by increasing aggregate deposits, the resulting fall in interbank lending is also costly; because the interbank market helps banks monitor their counterparties. Therefore, low but positive aggregate deposits can be explained as the welfare-optimising point in the trade-off between stigma and monitoring costs (a novel contribution to the literature).