Within the tolerance range around its reserves target, a bank has no incentive to pay more than Bank Rate for an additional unit of reserves, or to charge less than Bank Rate for lending an additional unit of reserves, and the demand curve is relatively flat. The length of the flat portion of the curve depends on the size of the tolerance range set by the Bank. If the tolerance range is very small, market interest rates will be relatively sensitive to variations in  6  If the system as a whole already has excess reserves (relative to the commercial banks’ collective target), the Bank can drain reserves by issuing short-term Bank of England bills. BIS central bankers’ speeches  3  the supply of reserves. That is because small variations in supply could potentially move banks into using the deposit or lending facility. If the tolerance range is very wide then banks have little or no incentive to distribute reserves around the market to meet their targets precisely. Alternative frameworks for setting interest rates This system of reserves targets is just one of a number of systems that would be used to implement the policy rate. Indeed, as a system for influencing market rates, these arrangements could be seen as overly complicated. Since March 2009, when the Bank embarked on its asset purchase program known as QE, we have been implementing Bank Rate in a rather simpler fashion. The Bank’s asset purchases were financed by creating additional central bank reserves.
The clearing spread for the narrow set would remain 10bps (bidder 6, as the cheapest narrow bidder, would be allotted only £ against his bid for £ The clearing spread for wider collateral would be 19bps £ would be allocated to bidder 1). That results in a stop-out spread (the difference between the clearing spreads for wider and narrow collateral) of 9bps. The stop out spread remains at 9bps until the point at which £ is allocated to the wider set. At that point, bidder 6 is no longer filled, and the clearing spread on the narrow set rises to 12bps. Bidder 1 receives £ out of the £ he has bid, and so the clearing spread remains at 19bps on wider. But the stop out spread is then 7bps (Chart 5). At the point where £ is allocated to wider, the clearing spread on narrow is still 12bps (bidder 6 is unfilled, and bidder 5 gets £ against a bid of £ but the clearing spread on wider falls to  16  8  Strictly, the stop-out spread is not defined if the allocation is 100% to one type of collateral. BIS central bankers’ speeches  17bps (bidder 1 is fully allocated and bidder 2 gets £ The stop out spread falls to 5bps (Chart 5). Continuing this process, and tracing out the spectrum of stop out spreads and the associated proportions of the funds allocated to wider collateral, results in the auction demand curve.