The Bank of England’s Imperfect Intervention by Willem H. Buiter & Anne C. Sibert

Following a newly installed government’s announcement of large, unfunded fiscal stimulus measures, the Bank of England had no choice but to intervene to stabilize financial markets. But in doing so, the BOE made errors and took shortcuts that should be avoided in the interest of preserving its policy credibility.

LONDON – Amid the political turmoil of outgoing British Prime Minister Liz Truss’s short-lived government, the Bank of England has found itself in the fiscal-financial crossfire. Whatever government comes next, it is vital that the BOE learns the right lessons.

On September 23, Truss’s government announced a large, unfunded fiscal-stimulus package that undermined the BOE’s price-stability mandate and caused government-debt and foreign-exchange markets to malfunction. To prevent systemically important markets from seizing up, the BOE postponed its planned offloading of government bonds (gilts) and instead purchased more. But these unsterilized (monetized) asset purchases amount to an expansionary monetary policy, which will further frustrate the BOE’s efforts to bring down inflation – unless and until the purchases are reversed.

Unfortunately for the BOE, it had no choice. Financial stability is a precondition for sustainable price stability, so it is a central bank’s overriding concern. When the circumstances demand it, central banks must act as lenders of last resort (LOLR) to preserve or restore funding liquidity for systemically important counterparties. They also must serve as market makers of last resort (MMLR) or buyers of last resort (BOLR) to maintain or restore market liquidity in systemically important financial markets.