8 https://bankunderground.co.uk/2019/04/30/the-great-war-and-the-bank-of-england-as-market-maker-of-last-resort/ 9 https://libertystreeteconomics.newyorkfed.org/2020/08/market-function-purchases-by-the-federal-reserve.html 10 Ie the ability to transact in reasonable size at or close to mid-market prices prevailing prior to the trade – as discussed, eg in https://www.bankofengland.co.uk/financial-stability-paper/2015/the-resilience-of-financial-market-liquidity 5 6  5  All speeches are available online at www.bankofengland.co.uk/news/speeches and @BoE_PressOffice  5  But it wasn’t until 2007, in the foothills of the Global Financial Crisis (GFC), that Willem Buiter and Anne Sibert coined the phrase now widely used for this activity: ‘Market Maker of Last Resort’ (MMLR).11 Buiter and Sibert believed that central banks, acting as MMLR, should be ready to tackle dysfunction in securities markets relevant to monetary or financial stability, by making two way prices to buy and sell those securities, or lending against them. Risk would temporarily be transferred off dealers’ balance sheets, freeing up capacity to return market liquidity to more normal levels.12 In all other respects, they recommended following Bagehot’s principles: ie standing ready to operate at scale, but only at prices, rates and collateral haircuts that would protect public money and avoid moral hazard. Such terms, they believed, would also ensure that the central bank’s financial exposures naturally unwound as market conditions normalised, with purchased assets being sold back to the market, or repo exposures maturing. Many historical central bank operations in securities markets, including some undertaken in the 2008-9 crisis, involved one-way purchases, and hence did not have this self-liquidating feature.

The public authorities cannot afford to ignore such dysfunction if it reaches a scale that threatens financial stability. But equally we cannot rely on central bank medicine of the scale and duration seen in 2020 every time we see an inflammation. The costs, in terms of bloated public sector balance sheets and mispriced private sector risks, will be too high. And the policy actions needed to secure monetary and financial stability may not always be as well aligned as they have been during the current crisis. If financial markets are to support the increasing reliance placed on them safely, we must do more to reduce the scale of inherent vulnerabilities ex ante, and build better-targeted tools for dealing with financial instability caused by market dysfunction ex post. And that, in turn, requires work in three separate but self-reinforcing areas – as illustrated in Chart 2. 3  All speeches are available online at www.bankofengland.co.uk/news/speeches and @BoE_PressOffice  3  Chart 2: Strengthening market functioning  Step 1: reforms to strengthen the resilience of private non-bank financial institutions to liquidity shocks  Step 2: strengthened market-wide infrastructure  Step 3: Better targeted central bank backstops  Step 1 – ensuring that non-banks active in financial markets are more resilient to future liquidity shocks – is under way, co-ordinated by the Financial Stability Board.2 If successful, this should both reduce the likelihood of instability arising in the first place, and improve the private sector’s ability to deal with it, if it does occur.