Fourth, the defence of the exchange rate will create a liquidity shortage in the domestic money markets. The central bank may recoup the liquidity by expanding its domestic assets by lending to commercial banks and also to the government which is now unable to raise funds from the market due to the liquidity shortage. 2  Finn Kydland and Edward Prescott in their 1977 paper introduced this problem See, “Rules rather than discretion: The Inconsistency of Optimal Plans” Journal of Political Economy, 85: 473-92  3  Alex Cukierman has chosen to call the problem “Prisoner’s Dilemma”. See, Central Banking Strategy: Credibility and Independence (1992), MIT Press, p 17-8. 4  BIS Review 58/2009  Fifth, to pay interest on foreign loans and repay the principal, a central bank may be forced to make further foreign borrowings. This will enlarge the net foreign liability position and cause the interest payments to surpass the interest earnings. The losses so made will continue to mount, gradually eroding a central bank’s capital base. The end result will be the conversion of a central bank’s net-worth from positive to negative. At that stage, a central bank will become technically insolvent. It actually becomes insolvent when it is unable to make further foreign borrowing and the domestic high inflation makes it impossible for it to fund itself by further issuing currency. It is the duty of the auditors to be vigilant on the emergence of these signs and alert the management and legislators in time.
In May and June we purchased about $ million per day, or about one percent of average daily trading volume in the secondary market, and that pace declined to about $ million per day by September, or less than 0.1 percent. Currently, the SMCCF holds about $ billion of overall exposure across corporate bonds and corporate bond ETFs. This is less than 0.2 percent of the outstanding bonds in this $ trillion market.15 As we’ve said previously, if further improvement in market functioning occurs, we could slow SMCCF purchases further and potentially pause daily purchases entirely. Conversely, if market functioning measures indicate deterioration, the SMCCF remains available to ramp up support. Despite the small footprint of the CCFs, we know the signaling effects have been potent—indeed, this is the main channel through which these facilities have had an impact—and we remain watchful for the risk of creating distortions. One possibility could be that companies issue shorter maturities than they would otherwise to benefit from presence of the CCF backstop. So far, we see no evidence of this behavior; if anything, there has been a tendency toward refinancing maturing debt at longer tenors.16 Another distortion could be excessive amounts of corporate debt issuance based on future expectations of an official sector backstop. This “moral hazard” risk will bear watching over the coming years, but there are at least a couple of reasons to believe it’s muted in the current circumstance. For one thing, global pandemics are an extremely infrequent occurrence.