Chapter 10 describes the global bank run that began in September 2008 and the subsequent government interventions that followed. But to understand those events, and the further actions that policymakers can still take to resolve the problems of the banks and the wider economy, we need first to take a close look at the central banks, at their operations in the markets for short-term money, and how they can respond to a financial crisis.

We look first at the money markets where banks borrow and lend short term and at how these markets have been dislocated by the crisis. We then examine monetary operations, contrasting the usual ‘orthodox’ approach to monetary policy where the central bank targets the short-term rate of interest with the possibility of employing an ‘unorthodox’ approach to monetary policy, where the central bank instead concentrates on expansion of its balance sheet and the purchase of financial assets.

Finally this chapter looks at the various actions that central banks can take in a financial crisis, namely liquidity provision (increasing balances in commercial bank reserve accounts with the central bank), extended maturity ‘term lending’ and, in the extreme situation of a systemic banking panic, acting as ‘lender of last resort’. It examines the employment of these tools in the first year of the crisis, from August 2007 until early September 2008.

This chapter makes one key point that is not as widely understood as it should be.