Julia Giese and Charlotte Grace

In response to the global financial crisis, the Bank of England (BoE) began using Product-Mix Auctions (PMA) to provide liquidity insurance to financial institutions. The PMA, designed by Paul Klemperer, allows the quantity of funds lent against different types of collateral to react flexibly to the economic environment and market stress. It maximises overall surplus, or 'welfare', assuming bidders bid their true values for loans. Mervyn King, the then BoE Governor, described the BoE’s use of PMAs as 'a marvellous application of theoretical economics to a practical problem of vital importance'. In this post, we describe a staff working paper that shows that the PMA generates welfare gains relative to simpler alternative auction designs, which cannot achieve such fine-tuned responses.