The financial market crisis has given rise to enormous tensions on the money market and has posed a formidable challenge to central banks. They have responded to this challenge by using their instruments flexibly and expanding the way in which they have been deployed. This has made it possible to contain the crisis. However, despite all the measures taken, the money markets remain tense. The underlying lack of confidence cannot be removed by central bank action alone. Ultimately, it is the market participants themselves who must restore confidence.

With respect to actions taken by the central banks, several lessons can be learnt from the crisis. Central banks do not depend solely on the monetary policy rate in order to safeguard financial market stability, since they have a broad arsenal of liquidity management instruments at their disposal. Central banks must be in a position to inject large amounts of liquidity into the market at short notice, and also to withdraw such amounts. They must also be able to conduct operations with the largest possible number of counterparties, against a broad range of collateral, and in different maturity ranges. A standing loan facility is useful only if there is no excessive stigma attached to its use. Collateral swap facilities are an effective measure for increasing liquidity in the banking system without expanding central bank money. However, they should be used only in exceptional cases. The crisis has also highlighted the importance of holding an adequate level of foreign reserves in order to ensure financial stability.

There may have been some costs associated with recent central bank action: First, interventions aimed at safeguarding short-term financial stability could lead to greater ‘moral hazard’ in the long run and thus, in turn, present a risk to financial markets. Second, interventions could fuel inflation. Monetary policy is therefore challenged not only on the financial stability front, but also needs to be extremely alert to developments on the price stability front.