years, some firms ’ business models had been based on the assumption they could obtain liquidity easily and cheaply in wholesale funding markets. these models ended up being quite vulnerable to a disruption in market conditions. in these cases, managers needed to be very nimble, and probably a bit lucky, to re engineer their model quickly enough when conditions changed abruptly. some were not that lucky. the past year has re affirmed, contrary to some earlier predictions, the importance of the large core banks even in a world of more developed capital markets. banks are a key source of funding liquidity for other institutions operating in financial markets – securitisation vehicles, structured investment vehicles ( the so called sivs ), conduits, non bank intermediaries and so on. funding pressures on those vehicles were quickly transmitted back to the core banks in numerous countries. when shocks to markets occur, it is therefore doubly important that banks be able to manage their own funding needs. in many instances, this proved to be more difficult over the past nine months than bankers had anticipated. not surprisingly, the recent turmoil has prompted many calls for the regulatory community to devote more resources to ensuring that banks strengthen their liquidity management. the reviews under way will be most useful if they address liquidity issues under conditions of market disruption, when everyone is scrambling for liquidity, not just firm specific events. regulators will also be reviewing arrangements to facilitate the smoother functioning of markets at the national and international levels. but there is another, rather important, sense in which the word “ liquidity ” is used, and in which i will use it today. here i am referring to funds at the central bank – what we in australia call exchange settlement funds, though they have differing names in various other countries. these balances are used by banks and other participants in the payments system to settle their obligations with each other and with the reserve bank. individual institutions can borrow and lend these funds in the overnight market but, for the system as a whole, the only source of these funds is the central bank itself. 3 i turn now, therefore, to a discussion of central bank liquidity operations. central bank liquidity operations in normal times, liquidity operations are pretty straightforward. the central bank forecasts the inflows to and outflows from the system resulting from its own transactions and transactions of course, the way the central bank conducts its own operations will have an effect on market conditions more generally. to that extent,

glenn stevens : liquidity and the lender of last resort text of the seventh annual sir leslie melville lecture, anu - toyota public lecture series 2008 by mr glenn stevens, governor of the reserve bank of australia, at the australian national university, canberra, 15 april 2008. i thank vanessa rayner for assistance in compiling this address. the original speech, which contains various links to the documents mentioned, can be found on the reserve bank of australia ’ s website. * * * it is a great honour to be invited to deliver the melville lecture. sir leslie melville is one of the revered father figures of the economics profession, and of central banking, in australia. i cannot claim to have known him, or ever met him. but it does not take long in reading about his contribution to the economic life of the nation to see what a remarkable man he was. there are a number of people who have spoken eloquently of melville ’ s life, including previous speakers in this series. i cannot improve on those words. the interested reader can do no better than to consult a number of biographical essays written by selwyn cornish, 1 ian macfarlane ’ s inaugural melville lecture in 2002, and the first hand, and rather poignant, reminiscences in ross garnaut ’ s 2004 lecture. my topic today is one that i think melville would have been interested in, namely, the role of central banks as providers of liquidity and as lenders of last resort in times of crisis. i say “ would ”, because there is nothing about it in his writings that i have been able to uncover. perhaps this is because in the 1930s depression there were few bank failures in comparison with that in the 1890s, and other macroeconomic issues were more to the fore. 2 but there was some discussion at the commonwealth bank during the 1930s about supporting other institutions. melville must have seen at least some of that discussion though it would have been very early in his time there. by the mid 1940s, moreover, melville was intimately involved in the international discussions that led to the establishment of the imf, which in many respects was intended to address the same issues in an international setting. had he been working in the circumstances in which we have lived recently, i am sure melville would have been very engaged in discussion about the role of the central bank. so it seems an appropriate occasion on which to review our thinking on this important matter. with that assertion then, let me proceed. i shall