Between September 1998 and Spring 1999 the liquidity of the Hungarian inter-bank money market and the corresponding interest rates for overnight funds showed significantly larger fluctuations relative to the previous periods. This study aims to analyse the causes behind the imbalances experienced during this period, and also to draw some lessons for monetary policy and operations.

Fluctuations in overnight interest rates are largely irrelevant for monetary policy unless they spill over to longer maturities as well. This usually does not happen, however, as our econometric results show, in the period considered fluctuations in liquidity had a considerable impact on the 3-month inter-bank interest rate.

The hectic fluctuations in liquidity were partly due to the Russian crisis and to the changes implemented in the MNB's set of monetary instruments. However, deficiencies in the commercial banks' liquidity management also contributed to the market turbulence. The analysis of market data revealed several occasions where market players behaved irrationally, and such behaviour resulted in long-lasting periods of disequilibrium on the money market. Reducing the maturity of the MNB's key policy instrument from one month to two weeks alleviated the fluctuations in liquidity; however, it could not resolve the problems arising from the inherent inefficiency of the inter-bank money market.