perhaps natural – misunderstanding of the different purposes of these interventions. the gilt purchases were intended as a monetary policy operation to inject a substantial amount of money into the economy. the consequences of that policy have been addressed in bank publications ( bank of england, quarterly bulletin, june 2009 for example ), speeches and elsewhere. there has been much less discussion about the private sector asset purchases. so to address that topic tonight, i would like to first set out some principles, as i see them, behind the actions of central banks in so called “ credit - easing ” operations. the announcement is at http : / / www. hm - treasury. gov. uk / press _ 05 _ 09. htm. subsequent letters exchanged between the governor and chancellor were published on 29th january and can be found at http : / / www. bankofengland. co. uk / publications / news / 2009 / 005 and those published on 5th march can be found via http : / / www. bankofengland. co. uk / publications / news / 2009 / 019. htm. the letters published on 5th march were dated 17th february, from the governor, and 3rd march from the chancellor. intervention by the authorities the bank of england intervenes routinely in financial markets so as to implement monetary policy and provide liquidity insurance to the banking system. these operations, normally restricted to banks and building society counterparties, stem directly from the bank ’ s core responsibilities of maintaining monetary and financial stability. but these responsibilities do not give the bank a mandate or the ability to provide a source of long - term funding for the commercial banking system 2, nor is it for the bank to take material risks with public money. in the case of monetary policy, the central bank expands and contracts its balance sheet to meet its objectives. typically that involves injecting and / or draining cash ( central bank money ) in order to set interest rates or, as with quantitative easing programmes, changing the money supply directly. the bank also provides liquidity support to commercial banks in times of stress ( for example through its discount window facility ). but such lending is well - collateralised, so low risk, and is always intended to be temporary : to overcome a one - off shock or to bridge to a more lasting solution. to discourage reliance on these operations, standard practice is to charge a penalty rate relative to market prices. these liquidity insurance operations are an integral part of the sterling monetary framework which delivers our monetary

behaviour fuelled the credit binge that ultimately led to the global crisis. second, if markets always clear, they should possess a natural stability. evidence to the contrary must be the product of market distortions or a result of incomplete markets. much of financial innovation springs from the logic that the solution to market failures is to build new markets on old markets. 7 progress through infinite regress. during the great moderation, such thinking became an organising principle for financiers and policymakers. the latter pursued a light touch regulatory agenda in quest for the perfect world of complete markets first described by the economists arrow and debreu. 8 their world imagines self - interested, atomistic agents, coolly calculating odds over all future possible states of the world, writing and trading contracts with each other, all frictionlessly enforced, all achieving mutually beneficial – indeed socially optimal – outcomes. of course, markets only clear in textbooks. in fact people are irrational, economies are imperfect, and nature itself is unknowable. when imperfections exist ( which is always ), adding markets can sometimes make things worse. take credit derivatives, which were supposed to complete a market in default risk and thereby improve the pricing and allocation of capital. financial alchemy seemed to have distributed risk, parcelling it up and allocating it to those who wanted most to bear it. however, the system had only spread risk, contingently and opaquely, in a way that actually ended up increasing it. risk ended up concentrated on the balance sheets of intermediaries that were themselves capital constrained. with the fates of borrowers and lenders tied together via hyper - globalised banks and markets, problems at the core spread violently to the periphery. a truth of finance is that the riskiness of an asset depends on who owns it. when markets don ’ t always clear, the ultimate owner may be surprised to find what they do own. when that surprise is – or is thought to be – widespread, panic ensues. the impossibility of completing markets was not the only practical problem with the pre - crisis approach. even if markets were perfect, nature itself is unknowable. recall that the arrow - debreu world relies on people being able to calculate the odds of each and every possible scenario. keynes, j m ( 1936 ), chapter 12. but economists of a more nuanced persuasion pointed out as far back as the 1950s that this logic is flawed. see lipsey