Monetary policy in the advanced industrial economies

Monetary policy in the advanced industrial economies faced two conflicting challenges during the period under review. On the one hand, tensions in financial markets threatened to spill over into the real economy by way of tighter credit conditions and a loss in confidence. On the other hand, inflationary pressures that stemmed from rising commodity prices, together with high capacity utilisation and tight labour markets in many economies, threatened to feed into longer-term inflation expectations. Differences in the manifestation of these challenges across countries and regions can explain, at least in part, why central banks dealt with them in different ways. For example, the Federal Reserve reacted forcefully by cutting its policy rate from 5.25% to 2%, whereas the ECB and the Bank of Japan kept their policy rates unchanged.

Changes in interest rates were only one measure through which central banks responded to the dislocation in financial markets. Even before the turbulence led to any changes in policy targets, central banks in several countries had adjusted their operations in a number of extraordinary and unprecedented ways to keep reference rates near targets and to provide financing in markets where liquidity had evaporated. The various types of operations and the reasoning behind them are discussed in the final section of the chapter.