paul fisher : recent developments in the sterling monetary framework speech given by mr paul fisher, executive director, markets, and member of the monetary policy committee of the bank of england, at the manchester economics seminar, manchester, 30 march 2011. all speeches are available online at www. bankofengland. co. uk / publications / speeches. * * * i would like to thank sarah ashley, roger clews, ronnie driver, tarkus frost, chris salmon, olaf weeken, iain de weymarn and richard whisker for their help in preparing this paper. introduction during the recent financial crisis and ensuing recession, the implementation of monetary policy has been the subject of intense debate. most visibly, that debate focused on the bank ’ s use of large - scale asset purchases – otherwise known as “ quantitative easing ” ( qe ) – as a monetary policy tool. but other aspects of the mechanics of setting policy have also been of great interest. in this paper, i want to focus on two issues which go to the heart of central banking : ( i ) the first concerns how the bank should seek to implement the monetary policy committee ’ s ( mpc ) decisions on the official interest rate ( known as bank rate ), so as to best deliver a flat money market yield curve between one mpc decision and the next. ( ii ) the second is about how best to provide liquidity insurance to the banking system as a whole, while also encouraging banks to manage their day - to - day liquidity needs, and subject to minimising the credit risk taken on the bank ’ s balance sheet. before explaining the bank ’ s thinking about these two issues, we need to lay out some basics about the bank ’ s objectives, and how it seeks to meet them using its balance sheet. the bank of england ’ s objectives and its balance sheet the bank has two core purposes : maintaining monetary stability and contributing to the stability of the financial system. with some variations, these are the two cornerstones of policy for most central banks around the globe. monetary policy is quite widely understood in a general sense – the bank specifically defines it to mean price stability and confidence in the currency. 1 financial stability is less well understood generally but it entails detecting and reducing threats to the financial system as a whole, in order to make it more resilient. 2 one major reason why it is for the central bank to pursue both of these purposes is because it has a balance sheet that can

which we now turn. longer - term open market operations the most routine method for ensuring there is the correct amount of sterling in the system, consistent with reserves targets, is via short - term omos. prior to the start of qe, the bank carried out weekly short - term reverse repo operations ( strs ) against a pool of “ narrow ” collateral comprising highly liquid sovereign or near - sovereign bonds from a small selection of countries. at that frequency, the scale of the operations could be judged fairly precisely so as to offset any autonomous factors which affected the net supply of sterling to the market. but relying solely on short term omos could have meant carrying out very large repo operations every week. to avoid that degree of churn, some longer term reverse repos ( ltrs ) were also used precrisis – at maturities from 3 to 12 months. those operations could be backed by either narrow or “ wider ” collateral, which comprises high quality, but less liquid collateral, including private sector securities. 10 the ltrs effectively reduced the quantity of lending needed via the routine weekly omos. but during the crisis, the demand for liquidity rose significantly, owing to the combination of a reduction in the supply of longer - term interbank finance, and a reduction in the liquidity of various asset - backed securities. the bank responded by expanding the range of collateral it would accept in its operations in order to provide sufficient sterling liquidity to the uk banking system. as a result, the stock of ltrs rose from £15bn to £180bn by early 2009 ( the blue area in chart 2 ). 11 the bank also widened the ranges around the commercial banks ’ targets, so that they could hold additional reserves ( within the maintenance period ) without penalty. the bank was concerned that the banks would collectively not increase their targets enough from one maintenance period to the next. widening the ranges around these targets, permitting a larger liquidity injection at the bank ’ s discretion, also addressed that problem. the temporary expansion of ltr lending during the crisis was very successful in its main objective of providing liquidity to the banking system. but it also raised a number of important operational policy questions for the bank : ( i ) it was very difficult to decide exactly how large these lending operations should be. ( ii ) it was also difficult to decide the appropriate spread to charge for lending against wider relative to narrow collateral, to mitigate adverse selection and the moral hazard risk. a minimum