Ben S Bernanke: Policy coordination among central banks
Speech by Mr Ben S Bernanke, Chairman of the Board of Governors of the US Federal
Reserve System, at the Fifth ECB Central Banking Conference "The Euro at Ten: Lessons
and Challenges", Frankfurt am Main, 14 November 2008.
* * *
I am pleased to be here in Frankfurt today to celebrate the 10th anniversary of the euro. The
euro's introduction was a remarkable achievement. As an academic, I did a bit of consulting
for the European Monetary Institute, the European Central Bank's (ECB) predecessor, on
monetary transmission mechanisms; I thus played a part, albeit an extremely small one, in
this grand project. I mention this only as a reminder that the creators of the euro drew on
monetary expertise from around the world, an early example of the international cooperation
that has since proven to be one of the hallmarks of the ECB. Indeed, the run-up to the euro's
establishment and the experience of the past decade have been associated with an
unprecedented degree of policy coordination among the sovereign states within the euro
area, including cooperation in the areas of fiscal and regulatory policies as well as monetary
policy.
The current financial crisis and global economic slowdown likewise have been an occasion
for unprecedented international policy coordination, within Europe but also globally. For
example, in its regulatory capacity, the Federal Reserve has worked closely with regulators
and supervisors from a number of European nations, and we are active participants in the
international Financial Stability Forum and the standard-setting bodies operating under the
aegis of the Bank for International Settlements. My focus today, however, will be cooperation
in monetary policy and, especially, in the meeting of the liquidity needs of our increasingly
globalized financial markets.
As you know, financial markets remain under severe strain. The proximate cause of the
financial turmoil was the end of the U.S. housing boom and the attendant losses on
mortgages and mortgage-related assets by many institutions. However, more fundamentally,
the turmoil was the product of a global credit boom, characterized by a broad underpricing of
risk, excessive leverage by financial institutions, and an increasing reliance on complex and
opaque financial instruments that have proven to be fragile under stress. The unwinding of
this boom (and the associated financial losses) has led to the withdrawal of many investors
from credit markets and deleveraging by financial institutions, both of which have acted to
constrict available credit to households and businesses. This credit squeeze is, in turn, a
principal cause of the economic slowdown now taking place in many countries.
Central bankers have been working closely together throughout this period of financial
turmoil. Personally, I have found the opportunity to share views regularly with President
Trichet and other leading central bankers at various international meetings extremely
valuable. We are all in frequent contact by phone as well. Our consultations allow us to keep
abreast of developments in other countries, to compare our analyses of developing trends,
and to draw on each other's experience and knowledge.
The merits of coordinated monetary policies have been discussed by policymakers and
academics for decades, but in practice, such coordination has been quite rare. However, on
October 8, the Federal Reserve announced a reduction in its policy interest rate jointly with
five other major central banks - the Bank of Canada, the Bank of England, the ECB,
Sveriges Riksbank, and the Swiss National Bank (SNB) - with the Bank of Japan expressing
support. Last month's joint action was motivated by the abatement of inflationary pressures
and increased indications of economic slowing in our respective economies. In addition, the
coordinated rate cut was intended to send a strong signal to the public and to markets of our
resolve to act together to address global economic challenges.
As you know, however, monetary policy actions have not resolved the ongoing strains in
financial markets, including interbank funding markets. The Federal Reserve has responded
to the strong demand for funding by banks and primary dealers by dramatically increasing
the amount of term funding that it auctions to banks, providing new lending facilities for
nonbanks, supplying high-quality securities for use in repurchase agreement (repo) markets
and for other collateralized lending, and funding purchases of commercial paper. Elsewhere,
including Canada, the euro area, and the United Kingdom, central banks have introduced or
expanded similar measures to boost the provision of liquidity in their local currencies. In
addition to these measures, governments in many countries broadened deposit insurance
coverage and announced plans to inject capital into their banking systems and to guarantee
bank debts. All of these steps are consistent with the principles agreed to by the Group of
Seven finance ministers and central bank governors in their October 10 communiqué.
Although the range of mechanisms we have used has been broad, our provision of liquidity
conforms to a central bank's traditional role as the lender of last resort. However, a novel
aspect of the current situation is that the balance sheets of financial institutions have
increasingly come to include instruments denominated in foreign currencies. The need for
currencies outside an issuing country's markets arises primarily from the global role played
by key international currencies, such as the dollar and the euro. For example, over the past
decade, international loans and deposits have grown tremendously, as has the issuance of
international debt securities - that is, bonds, notes, and money market instruments sold
outside the borders of the borrower's country and sometimes denominated in foreign
currencies. These developments have posed new challenges for conventional central bank
liquidity and lender-of-last-resort policies. For example, injecting euros or sterling into
national money markets may not be sufficient to restore market function in these economies
when funding shortages are in dollars.
Indeed, a significant feature of the recent financial market stress is the strong demand for
dollar funding not only in the United States, but also abroad. Many financial institutions
outside the United States, especially in Europe, had substantially increased their dollar
investments in recent years, including loans to nonbanks and purchases of asset-backed
securities issued by U.S. residents.1 Also, the continued prominent role of the dollar in
international trade, foreign direct investment, and financial transactions contributes to dollar
funding needs abroad. While some financial institutions outside the United States have relied
on dollars acquired through their U.S. affiliates, many others relied on interbank and other
wholesale markets to obtain dollars. As such, the recent sharp deterioration in conditions in
funding markets left some participants outside the United States without adequate access to
short-term dollar financing.
The emergence of dollar funding shortages around the globe has required a more
internationally coordinated approach among central banks to the lender-of-last-resort
function. The principal tool we have used is the currency swap line, which allows each
collaborating central bank to draw down balances denominated in its foreign partner's
currency. The Federal Reserve has now established temporary swap lines with more than a
dozen other central banks.2 Many of these central banks have drawn on these lines and,
using a variety of methods and facilities, have allocated these funds to meet the needs of
institutions within their borders.3 Although funding needs during the current turmoil have
been the most pronounced for dollars, they have arisen for other currencies as well. For
example, the ECB has set up swap lines and repo facilities with the central banks of
Denmark and Hungary to provide euro liquidity in those countries. The terms of many swap
agreements have been adjusted with the changing needs for liquidity: The sizes of the swaps
have increased, the types of collateral accepted by these central banks from financial
institutions in their economies have been expanded, and the maturities at which these funds
have been made available have been tailored to meeting the prevailing needs. Notably, in
mid-October, the Federal Reserve eliminated limits on the sizes of its swap lines with the
ECB, the Bank of England, the SNB, and the Bank of Japan so as to accommodate demands
for U.S. dollar funding of any scale. Taken together, these actions have helped improve the
distribution of liquidity around the globe.
This collaborative approach to the injection of liquidity reflects more than the global,
multicurrency nature of funding difficulties. It also reflects the importance of relationships between
central banks and the institutions they serve. Under swap agreements, the responsibility for
allocating foreign-currency liquidity within a jurisdiction lies with the domestic central bank.
This arrangement makes use of the fact that the domestic central bank is best positioned to
understand the mechanics and special features of its own country's financial and payments
systems and, because of its existing relationships with domestic financial institutions, can
best assess the strength of each institution and its needs for foreign-currency liquidity. The
domestic central bank is also typically best informed about the quality of the collateral offered
by potential borrowers.
The efforts by central banks around the world to increase the availability of liquidity, along
with other steps taken by central banks and governments, have contributed to tentative
improvements in credit market functioning. However, the continuing volatility of markets and
recent indicators of economic performance confirm that challenges remain. For this reason,
policymakers will remain in close contact, monitor developments closely, and stand ready to
take additional steps should conditions warrant. In times like these, we are especially aware
of the importance of having close working relationships with our central bank colleagues
around the world. These relationships are fostered by the ties established in forums like this
one and in the many venues where policymakers regularly gather.
The 10th anniversary of the euro is an opportunity not only to celebrate an impressive and
historic achievement, but also to reaffirm our commitment to cooperation as we address the
challenges of an increasingly integrated global economy. Central bankers and other
policymakers around the world must continue to work together to address disruptions in
credit markets and to promote a vibrant global economy.