IMF Assesses Central Banks' Reaction to Subprime Crisis
| Author | Simon Gray and Peter Stella |
| Position | IMF Monetary and Capital Markets Department |
| Pages | 22-23 |
Page 22
The IMF is assessing the different approaches taken by the major central banks in response to financial market turmoil sparked by the subprime crisis. This will allow the IMF to help draw lessons for developing a more effective liquidity management framework.
The IMF has already held discussions with central bankers and market participants in Europe, Asia, and North America. The IMF believes that an examination of the different approaches followed by the European Central Bank (ECB), the U.S. Federal Reserve (Fed), and the Bank of England (BoE) holds lessons that could be useful to all central bankers.
The financial turmoil that broke out in August 2007 presented major challenges to a number of industrial-country central banks, in particular the ECB, the Fed, and the BoE.
Central banks in normal times aim to provide sufficient liquidity to the financial markets at or around the policy interest rate (the monetary policy interest rates set by the ECB's Governing Council, the Fed's Federal Open Market Committee, and the BoE's Monetary Policy Committee), with the expectation that
* their counterparties-the commercial banks and securities firms that deal directly with the central bank in open market operations (OMO)-will distribute liquidity among market participants as needed, and
* there is a reasonably stable relationship between, on the one hand, the very short-term interbank rate that the central bank targets and, on the other, the longer-term money market rates that influence demand in the economy.
The subprime crisis, which began in the United States, disrupted market functioning, with the result that previously stable relationships in the wholesale money markets in both the United States and Europe broke down; the yield curve became steeper and more volatile; and the gap between secured and unsecured rates widened. For the Fed, in particular, the impact of the subprime crisis also required a reappraisal of its monetary policy stance: the target rate was cut in several steps from 5.25 percent immediately prior to the crisis to 3 percent by the end of January, to offset economic weakening and tighter credit conditions.
Central banks typically make available a standing...
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