Date Added: Nov 2010
An increasing number of central banks implement monetary policy via two standing facilities: a lending facility and a deposit facility. In this paper the authors show that it is socially optimal to implement a non-zero interest rate spread. They prove this result in a dynamic general equilibrium model where market participants have heterogeneous liquidity needs and where the central bank requires government bonds as collateral. They also calibrate the model and discuss the behavior of the money market rate and the volumes traded at the ECB's deposit and lending facilities in response to the recent financial crisis.