how to achieve that is given by walter bagehot ’ s description of the ‘ lender of last resort ’ ( lolr ), which ( in essence ) recommends stemming financial panics by lending freely, to sound institutions, against good collateral, and at rates materially higher than those prevailing in normal conditions. 6 for much of their lifespan, central banks have provided lolr primarily to commercial banks. banks specialise in lending to households and firms, but are inherently vulnerable to liquidity risk, given the maturity mismatch between their long - term assets and their short - term liabilities. over time, and the experience of successive banking crises, lolr has been supplemented by an extensive prudential regulatory regime, requiring banks to take greater ownership of managing their own risks, and setting quantitative minima for liquidity buffers. in short, a banking version of chart 2. 7 but while lolr may have been primarily focused on banks, there are also historical precedents for central banks stepping in to restore broader market functioning at critical moments. in july 1914, for example, the bank of england made large - scale purchases of bills of exchange after the uncertainty caused by the onset of world war 1 brought the market to a halt, threatening widespread contagion ( the bill market was at that time the engine of global trade finance ). 8 the federal reserve took similar actions in the us treasury bond market in 1939 ( at the start of world war 2 ), 1958 ( following a regime change in government funding arrangements ) and 1970 ( amidst unrest over the vietnam war ). 9 by degrees, these and other actions show a gradual broadening in focus by central banks from backstopping the funding liquidity of banks to backstopping market liquidity, 10 when severe dysfunction threatens financial stability. ‘ currency and credit ’ ( 1919 ) and ‘ the art of central banking ’ ( 1932 ), by ralph george hawtrey. ‘ lombard street : a description of the money market ’ ( 1875 ), by walter bagehot. these tools have been further supplemented by deposit insurance, macroprudential and resolution frameworks, though these are typically more focused on solvency than liquidity considerations. https : / / bankunderground. co. uk / 2019 / 04 / 30 / the - great - war - and - the - bank - of - england - as - market - maker - of - last - resort / https : / / libertystreeteconomics. new

increasingly relied on by households and firms, if business model vulnerabilities persist and intermediation capacity remains strained. 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. all speeches are available online at www. bankofengland. co. uk / news / speeches and @ boe _ pressoffice 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. step 2 relates to the potential for market participants, acting on their own or in concert with the authorities, to reduce vulnerabilities by strengthening market - wide infrastructures or practices. the recent proposal by darrell duffie to mandate central clearing of us government bonds is an example of this type of work. 3 but my topic today relates to step 3 : the role that central bank balance sheets should play in dealing with market dysfunction. i deliberately come to this last, because, while it is central banks ’ job to restore financial stability where self - insurance is too socially costly, they should be backstop providers of liquidity, not a first port of call. in that sense, their tools should complement, not substitute for, the other vertices of the triangle. outside of pandemics,