7.2 Monetary policy in the crisis

In the liquidity trap, central banks face the problem of having to control (or expand) the money supply without being able to lower the interest rate. The following bundle of measures are available to them:

• Amendment of central bank guidelines to allow banks to receive money
• open-ended and long-term liquidity provision (refinancing operations with multi-annual terms)
• Fixed rate tenders instead of variable rate tenders
• Acceptance of lower rated securities
• Liquidity assistance program
• Permission for national central banks to provide liquidity in case of crisis

Central banks act as consumers in certain markets in order to stabilize them and thus prevent a deterioration of the balance sheet of banks engaged in these markets. Hence, the ECB buys certain bonds so they do not lose value, because some of the banks that own these bonds would not be able to absorb the losses. Central banks buy government bonds or government-guaranteed bonds to increase the money supply.