Changes in central bank money market operating procedures in the 1980s
BIS Economic Papers No 23
In the last few years central banks have made extensive changes in the procedures they use for regulating bank reserves and influencing developments in short-term interest rates. Such money market operations have long been the principal means for implementing monetary policy in some industrial countries, particularly in large ones with broad financial markets. Money market policy has, however, assumed a larger role in recent years as reliance on direct credit and interest rate controls in domestic monetary management has declined as financial markets have become more integrated internationally.
Though the techniques employed by individual central banks in their money market operations are still strongly influenced by differing institutional, legal and political environments, common aims and tendencies can be observed in the recent changes. In general terms, innovations affecting the use of central bank credit facilities, new market instruments and the adaptation of reserve requirements have been designed to make the implementation of money market policy more flexible and to ensure its effectiveness in a more complex environment.
The essential characteristics and objectives of central bank operating procedures can be set out and compared in a fairly simple analytical framework. The central bank has a monopoly of the note issue, acts as banker to the banks and the government, and normally also operates the interbank clearing system. In most countries the central bank also holds the official external currency reserves of the country and may purchase domestic securities for its own account. All these functions are reflected in the central bank's own balance sheet. Provided the central bank has adequate control over developments in its total assets and liabilities other than bankers' deposits, it is in a position to control the terms under which banks can obtain the central bank balances they wish to hold for clearing purposes or need for meeting compulsory reserve requirements. The credit or market instruments which the authorities use for making marginal adjustments to the reserve position of the banking system influence interest rates in markets used by individual banks as alternatives for making reserve adjustments - particularly the interbank market. Indirectly they also influence interest rates on banks' short-term borrowing and lending operations and other interest rates in the economy.
The central bank's money market operations may be guided by proximate or operating guides for money market interest rates or for bank reserves. These normally have to be set and adapted flexibly in order to meet more basic objectives. In many cases the operating objectives have been designed to be consistent with the achievement of intermediate targets for the growth of the money stock or for particular exchange rate relationships. Money market policy in Group of Ten (G-10) countries - on which this paper focuses - does not, however, rely to any significant extent, or even presuppose, direct causal influences running from the volume of bank reserves to the money stock. Except to the extent that they have influenced the central banks' money market operating procedures, the intermediate and final objectives of monetary policy are not discussed in this paper.
Some general characteristics of the recent changes in central banks' money market procedures and the reasons for them are identified in Section II of this paper. A framework for analysing the impact of these operations on the supply of and demand for bank reserves and on the determination of interest rates in the money market is set out in Section III. The following three sections outline the changes which have taken place in individual countries in central bank credit facilities, market instruments and reserve requirements, and analyse in some detail the way the procedures now used in individual countries operate. Section VII turns to the link between control of money market and central bank credit to the government, and looks at the ways in which government debt management has constrained money market policy in individual countries. Section VIII discusses the impact of structural changes in money markets and of external constraints, which have become tighter in most countries in recent years, on the use of instruments. Throughout, the focus is primarily on comparisons of the problems encountered and the solutions adopted in different countries. Given that the changes in procedures are in many cases very recent and that for many countries the kind of daily or weekly data which would be needed for meaningful statistical analysis is not available or is difficult to access, the approach is essentially descriptive and graphical. The concluding observations contain some reflections on the likely implications of foreseeable further changes in the domestic and external environment for the effectiveness of the procedures central banks use in implementing money market policy.