A leading ESRC-funded economist helped to design and implement an auction system to ensure the Bank of England was able to direct money to banks that needed it most in the recent financial crisis.


Video: The Guardian

"The Bank of England's use of Klemperer auctions in our liquidity insurance operations is a marvellous application of theoretical economics to a practical problem of vital importance to financial markets." (Mervyn King, former Governor of the Bank of England)

Impacts

  • Running the Product-Mix Auction enabled the Bank of England to efficiently allocate money to the banks and building societies that needed it most urgently at a time of crisis
  • The Bank of England now uses the auction system on a regular basis to provide liquidity to the UK financial system
  • In October 2013 the current Bank of England Governor Mark Carney announced that the Bank would hold larger auctions to offer money at a lower cost and in exchange for a wider range of collateral.

About the research

As the financial crisis took hold in the UK in the wake of the collapse of Northern Rock in September 2007, the Bank of England realised it needed to supply liquidity urgently to the banks and building societies that needed it most.

The then-Governor of the Bank, Mervyn King, asked Paul Klemperer, Edgeworth Professor of Economics at the University of Oxford, to design a system for working out the best way to lend money against both safe government bonds and the more risky assets that many institutions held. The challenge was to design an auction that could very rapidly deliver the most efficient allocation of money to the right bidders

Klemperer used his long-standing research into auctions within economics to invent a new design known as the 'Product-Mix Auction': banks put in sealed simultaneous bids for a number of different assets in a way that allows the Bank of England to understand banks' individual preferences and so allocate the loans efficiently. Using geometric methods, Klemperer developed a design that both enabled the Bank to run the auction in a few minutes rather than days or weeks, and has other advantages over existing designs.

With the ESRC-funded research project 'Auctions for Multiple Goods, and Understanding Consumer Preferences' Klemperer is developing his design further using advanced geometry, including the new discipline of tropical geometry that has been devised by mathematicians only in the last 15 years. In February 2014 he advised the Bank of England on the implementation of an enhanced version of his original design. The new design is also applicable to many other contexts, such as energy markets.