Central Banks’ Response to Economic Uncertainty Raises Concerns: An Overview for Investors
Bank of Canada and Its Peers Stir Memories of the 2008 Financial Crisis: What You Need to Know
The announcement made by the Bank of Canada on March 19 that it would join hands with several global central banks to ensure unlimited access to U.S. dollars for banks created a stir among financial experts. This move aims to alleviate the fear of the global financial system.
The financial crisis of 2008 saw central banks use Sundays to devise unprecedented measures to restore calm before the markets opened in Asia and Australia on Monday. The bankers had to pull off extraordinary measures that went beyond their standard operating procedures.
The recent decision taken by central banks has brought back memories of the situation prevailing during the 2008 financial crisis. However, this collective action is more preventative than a response to an actual crisis. This move is a testament to central banks’ measures a decade ago to contain financial risk.
What Did the Bank of Canada Do on the Weekend?
The primary objective of central banks is to act as lenders of last resort in times of financial crises. They do this by ensuring that cash is readily available to lenders under conditions that are not attractive during normal times. This is the primary tool that central banks deploy to prevent a crisis’s contagion from spreading further.
Whenever the troubled lender needs local currency, central banks can create as much as required. However, when they require U.S. dollars, the available supply can quickly become scarce since many global goods and services are priced and traded in dollars. The ECB and the Bank of England have a considerable dollar reserve, but their supply is limited. During the 2008 financial crisis, the shortage of dollars disrupted Wall Street and the City of London’s cash flow, causing credit creation to freeze.
Central banks, led by the Federal Reserve (Fed), found a way out of this crisis by setting up swap lines, which allow a central bank to draw on other central banks’ dollar reserves (and other currencies) when they run short. As a result, the Fed effectively became the lender of last resort for the world.
After the Great Recession, central banks chose to sustain several programs to act as a safety net in case they were ever needed again. Fearing the market’s interpretation of a significant global financial institution’s near failure, the Bank of Canada and its peers decided on the weekend to ramp up the auctions for dollars daily, starting from March 20 rather than weekly.
These daily operations, which could last until the end of April, are important since they allow central banks to draw on each other’s dollar reserves, ensuring that the global financial system does not freeze as it did during the 2008 financial crisis.
- Central banks act as lenders of last resort by making cash available to lenders under specific conditions that would not be attractive under normal circumstances.
- Central banks found a way out of the 2008 financial crisis by setting up swap lines that allow a central bank to draw on other central banks’ dollar reserves when they run short.
- The Bank of Canada and several global central banks decided to ramp up auctions for dollars daily to ensure that the global financial system did not get frozen, just like it did during the 2008 financial crisis.
The recent announcement by the Bank of Canada and its peers brings back memories of the 2008 financial crisis. However, it is more a precaution than a response to an existing crisis. The measures taken by central banks in the past decade to contain financial risks have been successful, ensuring that the global financial system doesn’t face a repeat of the 2008 financial crisis.
Central banks’ primary responsibility is ensuring the global financial system remains stable during economic uncertainty. The recent decision by the Bank of Canada and several global central banks to ramp up auctions for dollars ensures that there is always enough cash to stave off any potential financial crisis.