Monday, March 23, 2009

Inflation Is A Risky Road Out Of Crisis

Posted By: Tsu-Han (Ina) Chang
By: Oxford Analytica
Central banks must address impaired loans and promote liquidity to kick-start their economies.
As central banks head toward the lower limit of interest rate cuts, the search has begun for alternative or unconventional monetary policy instruments.

Several options remain:
Interest rate spreads. Owing to risk aversion and information asymmetries regarding bank balance sheets, the difference between policy base rates and three-month interbank rates rose in October to about 1.5 percentage points (pp) in the euro-area and U.K. Thanks to liquidity operations, the gap shrank in January below 0.5 pp in the euro-area and to about 0.8 pp in the U.K. Continued liquidity provisions on the interbank market is a policy option left to central banks to reduce risk premiums on interbank rates and eventually on retail rates. It will probably remain a key policy instrument in the coming months to ensure the smooth day-to-day refinancing of the financial sector.

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