Discuss the Role Central Banks Have Played in Counteracting the Effects of the Financial Crisis

Topics: Monetary policy, Central bank, Inflation Pages: 3 (1109 words) Published: November 27, 2012
Discuss the role central banks (e.g. Fed, Bank of England) have played in counteracting the effects of the financial crisis. Argue how the monetary policy mandate might change in the future to avoid such crises.

As stated by Buiter (2008) the Central Bank has three main tasks. These are; '(1) the pursuit of macroeconomic stability; (2) maintaining financial stability and (3) ensuring the proper functioning of the ‘plumbing’ of a monetary economy'. The effectiveness of the Central Bank, during the financial crisis, will be discussed as well as how the Central Bank could change its monetary policies in order to avoid such a crisis in the future. The main focus will be on the Bank of England (BoE), the European Central Bank (ECB) and the Federal Reserve System (Fed). Each of the Central Banks have different objectives when it comes to monetary policy. The BoE concentrates on the target inflation set by the Chancellor of the Exchequer, which is 2 percent. The ECB has a similar objective although they can set target inflation themselves and it is usually just under 2 percent. The Fed on the other hand has two main aims; 'maximum employment, stable prices' (Buiter 2008). When the crisis hit, the Central Banks made some attempts to counteract it. Firstly, they broadened their role as a lender of last resort. They started to include 'liquidity support to non-deposit-taking institutions' (Blanchard, 2010). This allowed them to intervene either directly or indirectly with more companies. This occurred at the start of the crisis where overnight interest rates rose sharply in Europe leading to the ECB responding with a liquidity injection of '€94.8 billion worth of overnight repos' (Cecchetti, 2008). The Central Banks went on to drop interest rates. The aim of this was to allow banks to receive short-term funding at lower interest rates as well as reducing the demand for inter-bank loans (Cecchetti 2008). The hope was that lower interest rates would also encourage...

References: Blanchard, O., Dell’Aricca, G., Mauro, P. (2010), “Rethinking Macroeconomic Policy”, IMF Staff Position Note, http://www.imf.org/external/pubs/ft/spn/2010/spn1003.pdf
Cecchetti, S. (2009), “Monetary Policy and the Financial Crisis of 2007-2008”, mimeo,
Buiter, W. (2008), “Central banks and financial crises”, discussion paper series, http://eprints.lse.ac.uk/24438/1/dp619.pdf
Mishkin, F. (2011), “Monetary Policy Strategy: Lessons from the Financial Crisis”, NBER Working Papers, http://mms.st-andrews.ac.uk/mms/module/2011_2/S2/EC2008/Content/Mishkin%20%282011%29%3A%20Monetary%20Policy%20Strategy/Mishkin2011.pdf
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