August 25th, 2014, 4:07 pm
Hi,The following paragraph is from this article. The bold part is not clear to me. How would focusing on illiquid collateral would have removed the excess liquidity problem? Would someone please help me understand that?Central banks have not been doing the job of market maker of last resort effectively, indeed they have barely been doing it at all. Following the stock market collapse of 1987, the Russian default of 1998 and the tech bubble crash of 2001, all that the key monetary authorities have done is (1) lower the short risk-free interest rate and (2) provide vast amounts of liquidity against high-grade collateral only, and nothing against illiquid collateral. The result has been that the ?resolution? of each of these financial crises created massive amounts of high-grade excess liquidity that was not withdrawn when market order was restored and provided the fuel that would produce the next credit boom and bust . By focusing instead on illiquid collateral, it should have been possible to achieve the same effect with a much smaller injection of liquidity Thanks.