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Market Response to Policy Initiatives during the Global Financial Crisis

When the subprime crisis struck in the United States and especially when it spread to other advanced economies and pushed the global economy into recession, designing an effective policy response to the crisis became the number one priority for policymakers around the globe. The ultimate goal of wide-ranging central bank and government interventions was to address the fragility of banking systems and restore confidence in the financial markets.

Achieving these goals required a delicate consideration of the sources of stress and the availability of suitable remedies?all against heightened uncertainty about financial and macroeconomic prospects. Reaching consensus on how quick and aggressive policy actions should be, how much weight should be put on macroeconomic and financial sector policies, and what specific form they should take, particularly given various legal, political and other constraints, has been a challenge both at the national and global levels (Swagel (2009)).

The debate on what policy response would be most effective unfolded in real time, and first econometric analyses also appeared. They largely focused on the effectiveness of the Federal Reserve’s Term Auction Facility (TAF), with conflicting results (contrast, for example, Taylor and Williams (2009) and McAndrews, Sarkar and Wang (2008)). Some studies underscored the importance of the U.S. Federal Reserve’s commitment to provide unlimited U.S. dollar swap lines to other central banks in alleviating dislocations in the dollar swap markets (Baba and Packer (2009) and McAndrews (2009)).

Announcements of financial restructuring measures were found to have reduced bank credit default swap (CDS) spreads, including for foreign banks, with the magnitude of the impact correlated with the magnitude of resources pledged (Panetta et al. (2009)). The literature on the effectiveness of crisis policy response has been growing rapidly, with most analyses focusing on individual countries or specific policy measures.

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Market Response to Policy Initiatives during the Global Financial Crisis