The U.S. Federal Reserve, European Central Bank, and central banks of Canada, England, Japan, and Switzerland today announced a coordinated monetary action that could provide added assistance to interbank lending in the event of a further deterioration in global financial markets. Here I offer some thoughts on what the action signifies. First, a little background. U.S. monetary policy has gone through two distinct phases in trying to deal with the economic and financial challenges since 2008. The first phase was intended to address the breakdown of what in normal times were very liquid markets for short-term interbank loans or commercial paper. One of the tools that the Fed used for this purpose was the Term Auction Facility, which was created in December 2007 to provide an additional channel for U.S. banks to borrow from the Fed. The Fed lent almost $500 billion through the TAF in March of 2009, but the TAF has not been used since April 2010. Another emergency tool was the Commercial Paper Lending Facility, which began operations in October 2008 and lent as much as $350 billion in January 2009 before being closed in February 2010. A third tool used during the height of the crisis was currency swap agreements. As an example of how these work, the Federal Reserve might give the Bank of England 40 billion dollars in exchange for 22 billion pounds, with an agreement to swap the currencies back at some future agreed date. In the mean time, the Bank of England could use the funds to extend dollar-denominated loans to banks in the U.K. This might help ease some of the pressure on the interbank Eurodollar lending rates as reflected for example in high term LIBOR rates.

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