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Liquidity and Money Market Operations


  • Charles Goodhart



The relative liquidity of financial assets is significantly influenced by the Central Bank’s willingness to buy such assets, or to accept them as collateral, in the course of providing additional cash to banks. Those assets which the Central Bank will deal in for such purposes become more liquid, and more marketable, than those that the Central Bank will not. When the banking system as a whole is short of cash, it has no other recourse than to go to the Central Bank for assistance. The Central Bank has to provide this, since otherwise interest rates will rise very sharply, given the banks’ inelastic demand for cash reserves. A Central Bank’s choice, in practice, is the price (interest rate) at which it will supply the requisite cash, not the volume of high-powered cash reserves to supply. Normally a Central Bank will supply just enough cash to hold very short-term (e.g. overnight) rates close to the policy rate, chosen generally on broad macro-economic grounds, e.g. to maintain medium-term price stability.

Suggested Citation

  • Charles Goodhart, 2008. "Liquidity and Money Market Operations," FMG Special Papers sp179, Financial Markets Group.
  • Handle: RePEc:fmg:fmgsps:sp179

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    Cited by:

    1. Adam Gersl & Zlatuse Komarkova & Lubos Komarek, 2016. "Liquidity Stress Testing with Second-Round Effects: Application to the Czech Banking Sector," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 66(1), pages 32-49, February.

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