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Through its ten propositions the report analyses the nature of liquidity crises and what can be done to address them.
The paper is organised around ten propositions that cover the following issues: the distinction between idiosyncratic and systematic elements of liquidity crises; the growing reliance on funding liquidity in a market-based financial system; the role of payment and settlement systems; the need to improve liquidity buffers; the desirability of putting in place (variable) speed limits in the financial system; the proper role of (retail) deposit insurance schemes; the double-edged-sword nature of liquidity provision by central banks; the often misunderstood role of ‘monetary base’ injections in addressing liquidity disruptions; the need to develop principles for the provision of central bank liquidity; and the need to reconsider the preventive role of monetary (interest rate) policy.
The report concludes by saying that the global financial crisis has hammered home the importance of the evaporation of liquidity in the dynamics of financial distress. Policies aimed at preventing and addressing such crises have regained an urgency they had lost for some time. In designing appropriate policy responses, perhaps the most important lesson to bear in mind is an old one: while liquidity strains exacerbate crises, they are typically a symptom of deeper underlying weaknesses in the quality of balance sheets that build up slowly over the years. Addressing the build-up of those weaknesses holds the key to more effective and long-lasting remedies.