Corridor System and Interest Rates: Volatility and Asymmetry

The corridor system in its current form is believed to reduce the volatility of overnight interest rates and to eliminate any chance of persistent upward or downward bias. The model presented here serves to highlight two main findings: one is that a central bank can further reduce the volatility of overnight interest rates by allowing banks some flexibility to meet their reserve targets within a small range, as observed in the UK data. The second is that a seemingly symmetric corridor may be asymmetric in practice due to several distortions, as the UK and euro area data suggest.