main objectives of this series of conferences is to discuss the main lessons for public policies arising from developments in the international banking and financial sector. the continuation of the market turmoil does not allow me to talk to you with the benefit of detachment and the comfort of an ex - post assessment. however, i should like to take advantage of the occasion to share with you some considerations on the ecb ’ s response to the market turmoil drawing on the experience of the past year. i am very grateful to cornelia holthausen for her valuable contributions. 2. the separation between monetary policy formulation and its implementation central bankers have, naturally, eyed the developments of the past year of financial turmoil – and, particularly, their recent intensification – with great concern, as they have the potential to influence adversely the ability of central banks to steer monetary policy rates, affect the transmission mechanism of monetary policy and, more generally, may pose a threat to financial stability. once the credit concerns that had built up in the sub - prime mortgage market segment started to affect interest rates and traded volumes in the euro area money market, the ecb responded to these highly unusual market events by timely and forcefully adjusting its liquidity policy. i will not deal with the specificities of the ecb ’ s liquidity management over the past year – this will be carried out by the ecb staff in tomorrow ’ s session on “ the experience with crisis management ” – but i would like to stress one fundamental principle underlying our response to the turmoil : “ the separation principle ”. this principle relates to the dichotomy between the ecb ’ s monetary policy and its liquidity policy or, in other words, between the formulation and implementation of monetary policy. during the turmoil, the separation principle proved to be very effective. supported by the flexibility of its operational framework, the ecb was able to react in a flexible and quick manner to a changing market environment, and it allowed the steering of interest rates close to the policy rate by means of temporary quantity adjustments, albeit without increasing the aggregate supply of euro liquidity to the banking sector. the main objective of the ecb ’ s immediate and lasting responses to tensions in the money market was to keep under to control the very short - term interest rates as the first step in the transmission of monetary policy. broadly speaking, the ecb ’ s liquidity policy response consisted of three elements : first, it changed the timing of the liquidity provision within the maintenance period ( the so -

the euro area ”, cambridge university press. kashyap, a. and j. stein ( 2000 ) : “ what do a million observations on banks say about the transmission of monetary policy? ”, american economic review 90 ( 3 ), pp. 407 - 28. european securitisation forum ( 2008 ) : “ esf securitisation data report – q2 : 2008 ”. european central bank ( 2008b ) : “ the role of banks in the monetary transmission mechanism ”, ecb monthly bulletin, august 2008, pp. 85 - 98. see, for instance, altunbas, y., l. gambacorta and d. marquez ( 2007 ) : “ securitisation and the bank lending channel ”, ecb working paper no. 838, and ecb ( 2008a ). see, for instance, gropp, r., c. kok sørensen and j. lichtenberger ( 2007 ) : “ the dynamics of bank spreads and financial structure ”, ecb working paper no. 714. european central bank ( 2008c ) : “ the euro area bank lending survey ”, january 2008. 4. the role of uncertainty one of the most relevant features of the current turmoil has been the high degree of asymmetric information and the enormous increase in general uncertainty in the financial sector. i would like to distinguish between the two in the following way : 9 uncertainty owes mainly to imperfect information in relation to credit valuations. uncertainty generally increased during the summer of 2007, because market participants realised that the current practices used for valuations – often based almost solely on ratings – were no longer valid. with this type of uncertainty, market participants have difficulty in modelling the expected occurrence of defaults. credit spreads can widen, also at the short end. 10 another typical effect is the flight - to - quality phenomenon : as in previous episodes of high uncertainty, during the turmoil savers have shunned equity and credit risk products in favour of government bonds and commodities as well as cash and bank deposits. as a result, bank deposits increased significantly. the term asymmetric information, on the other hand, applies to an adverse selection problem, notably in the interbank market, where market players can no longer distinguish solvent from insolvent borrowers. such a “ lemon ’ s problem ” induces banks to demand high risk premia of their creditors and lead to a general increase in interbank