Central Bank Interventions During Episodes of Financial Market Dysfunction: Lessons for the Future

Excerpt

In March 2020, the onset of the Covid-19 pandemic triggered severe turmoil in financial markets threatening the stability of the global financial system. As the extent of the disruptions became clear, precautionary demand for cash surged. The impact of this unprecedented shock was greatly amplified by pre-existing vulnerabilities in financial markets and by the system of market-based finance. While hedge funds and other leveraged investors struggled to meet margin calls, strong bank capital and liquidity positions helped prevent a sharp rise in counterparty risks. But dealer banks nevertheless withdrew from repo markets, creating funding constraints. Markets for safe, normally highly liquid assets evaporated. Presented with extreme dysfunction in systemically important markets, central banks responded decisively, reviving and expanding programs first implemented during 2007-09 financial crisis to address near-term stability risks. These actions – which include large-scale asset purchases, market-maker of last resort activities, enhanced lender of last resort activities, and credit easing operations – substantially increased the size and altered the composition of central banks’ balance sheets. …