In the early days of the crisis, Ben Bernanke and Jean-Claude Trichet injected liquidity on an unprecedented scale to prevent a financial meltdown. Central bankers elsewhere did little to help their cause.
In fact, their reserve managers – the people responsible for investing monetary authorities’ foreign exchange stockpiles – made matters worse.
Reserve managers often stash a chunk of their stock piles in short-term bank deposits. But at the start of the crisis, research produced by the IMF found they had pulled about $500bn of deposits from the banking sector, contributing to financial instability in the process. This from the research:
IMF: Although clearly not the main cause, this pro-cyclical investment behaviour is likely to have contributed to the funding problems of the banking sector, which required offsetting measures by other central banks, such as the Federal Reserve and the Eurosystem central banks.
There is, as the paper notes, “a potential conflict between the reserve management and financial stability mandates of central banks”. And so news that Norway’s sovereign wealth fund (managed by the central bank, though the asset allocation strategy is decided by the finance ministry) will take on more risk during downturns is to be welcomed. Read more