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Central Bank Responses to the Money Market Turmoil Stemming from Subprime Woes: Review of the Initial Phase from August 2007 until July 2008*1

  • *1This is an English translation of the Japanese original released in July 2008. The paper reflects information available up to July 2008 but the charts in the paper use data available at the end of June 2008, unless otherwise stated.

March 27, 2009
Financial Markets Department
Bank of Japan

Click on ron0903a.pdf to download the full text.


The monetary operations of central banks generally consist of the following three components: reserve requirements, open market operations, and standing facilities. However, details differ depending on operating targets, financial market environments and historical factors. Subject to the reserve requirements, financial institutions are required to maintain a certain amount of reserves at a central bank during a certain period. This creates a demand for reserve balances that is stable relative to a financial institutions' fluctuating daily demand for settlement balances. The liquidity gap between total supply and demand for reserve balances fluctuates along with autonomous factors including banknote and treasury fund variations. A central bank fills this liquidity gap through their market operations and guides a market interest rate, generally an overnight rate, to a level consistent with its policy interest rate. Standing facilities lend funds and receive deposits at predetermined rates in response to requests from financial institutions. This helps control interest rates through market operations by setting upper and lower bounds for the market rate, when it is highly variable, and by promoting the view to market participants that those facilities are always available.

Basic framework of market operations is common among central banks, but management schemes differ among countries. They depend on the level, range and predictability of the underlying liquidity gap, which are affected by demand for banknotes and the administrative schemes that manage treasury funds. For instance, against a large fluctuation in liquidity gaps, the Bank of Japan (BoJ), which has a variety of operational tools at its disposal, conducts operations with various maturities at various times, while central banks in the United States and Europe, where the fluctuations are relatively small, conduct their market operations regularly.

Since August 2007, central banks have been required to adjust their management of monetary operations to address money market turmoil stemming from subprime woes. U.S. and European central banks, in particular, have attempted to stabilize markets and strengthen their ability to provide liquidity. They have not only conducted market operations in a timely and flexible manner while using conventional frameworks, but they have also introduced new measures for market operations. In addition, the U.S. and European five central banks made an unprecedented move to coordinate actions with regard to their market operations in December 2007 and March 2008. Central banks in the United States, the euro area and Switzerland took further coordinated actions in May 2008.

This paper reviews the response and management of central banks, including the Federal Reserve System in the United States, the European Central Bank (ECB) in the euro area, and the Bank of England (BoE) in the United Kingdom, with regard to their market operations after August 2007. The paper also briefly outlines the BoJ's responses while comparing those of other central banks.


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Financial Markets Department, Bank of Japan
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