Changes in market functioning and central bank policy: an overview of the issues

In recent years, a number of structural developments have had a significant influence on the functioning of financial markets. The most important of these developments are the introduction of the euro, the spread of electronic trading, shifts in the constellation and behaviour of market participants and changes in relative supplies of different assets. There is some evidence that such developments have led to shifts in liquidity among different market segments and, moreover, that market liquidity is less robust than in the past. Furthermore, some of the largest government securities markets have begun to lose their pre-eminence as centres for price discovery about macroeconomic fundamentals, while credit derivative, corporate bond and equity markets are all vying to become the locus for price discovery about credit risk. These changes in market functioning pose various challenges for central bank policy, including what role central banks should play in promoting robust liquidity, how best to gauge market expectations, and whether the conduct of monetary policy operations should be adjusted. This paper served as the background paper for the Autumn Central Bank Economists' Meeting held at the BIS on 15-16 October 2001. In addition to setting out the issues for discussion, it summarises the main findings of the other papers presented at the meeting (the full versions of which can be found in