Joint post by Willem H. Buiter and Anne C. Sibert. This post appeared first as a Comment in the Financial Times, Thursday, September 6, 2007.
Should the Bank of England do more to calm the money markets? During the current turmoil, it has been more hands-off than the European Central Bank, which has injected liquidity on a massive scale, and the Federal Reserve, which has injected liquidity on a modest scale and cut its discount rate by 50 basis points. The Bank is criticised by the City and some commentators for this "passive" policy stance. Would a more activist stance be appropriate?
Should the Bank have cut its policy rate? Neither the Fed nor the ECB has yet done so. The policy rate is not appropriate for addressing credit and liquidity crises. The Bank should cut Bank rate only if necessary to achieve its inflation target and, subject to that, to support the real economy. While Bank rate may well have peaked, there is no case for a cut now.
Should the Bank have cut its discount rate - the rate on overnight borrowing from its standing (collateralised) lending facility? We think not. It would be a bonus to those already willing and able to borrow at the discount window, but would do nothing to boost banks
Should the Bank have injected additional liquidity to keep interbank rates closer to its policy rate, using short-term repos (repurchase agreements) at the policy rate, longer-term repos at market rates or outright purchases? We believe the main problem is that eligible counterparties (banks, building societies and certain securities dealers) do not have eligible assets to offer as collateral or sell outright.
The gap between overnight money market rates and policy rates is not significantly higher in the
We believe there are three features of the
Second, like the Fed, the Bank should extend the term of its discount window loans from overnight to at least 30 days. Third, the Bank accepts as collateral at its discount window or in open-market purchases only instruments issued by European Economic Area central governments, central banks and major international institutions rated at least Aa3 (and, exceptionally, US Treasury bonds). This is too restrictive. The ECB accepts marketable and non-marketable securities rated at least A-, including securities issued or guaranteed by private entities. The Fed has been quite restrictive, but the Federal Reserve Act allows it to lend, in a crisis, to any institution,organisation or individual and against any collateral.
Faced with financial turmoil, the rule of thumb should be: if it can be valued, it is eligible as collateral at the Bank
What the Bank did on September 5 was mainly