Tuesday, September 20, 2011

Rethinking Central Banking

There’s plenty of blame to go around in looking at the causes of the Great Recession, and there’s also plenty of controversy and tension between major and emerging economies regarding the policies followed in its aftermath, in particular the role of monetary policies.

A new report published today discusses the future of central banking in this context:

Rethinking central banking

Central banks have massively broadened their remit in recent crisis-laden years, but the standard analytic framework – ‘flexible inflation targeting’ – has not changed. This column argues that it is time to properly flesh out an alternative framework. Financial stability should be an explicit mandate of central banks, and international coordination among central banks should be boosted by forming a small group of systemically significant central banks that regularly meets and issues reports to the G20 on their financial-stability policies.

The VoxEU article linked to above summarises the findings, but you can read the original report here. The authors are some of the heavy hitters of the economics and finance profession, so the report should be taken seriously. And the recommendations aren’t too far-fetched either, in fact largely in line with what many central banks have attempted both during and after 2008. Perhaps the biggest change from past orthodoxy is the addition of financial stability as an explicit mandate, and the backing of the use of macro and micro prudential tools.

An additional difference is a proposal for systemically important central banks to meet regularly, report to the G20, and (hopefully) coordinate and communicate their policies jointly. In the absence of a global central bank, this is perhaps the next best alternative to a unified global monetary policy. Whether anyone will actually implement any of this is of course another thing entirely.

Technical Notes:

Eichengreen et al, “Rethinking the Role of Central Banking", The Committee on International Economic and Policy Reform, The Brookings Institution, September 2011


  1. "Financial stability should be an explicit mandate of central banks"

    Explicit but not Exclusive bro hishamh

    Most financial regulatory systems throughout the world are designed primarily to ensure the soundness of individual institutions. The failure of large, complex, and interconnected financial firms can disrupt the broader financial system and the overall economy, and such firms should be regulated with that fact in mind. Likewise, the costs of the failure of critical financial infrastructures, such as payments and settlements systems, are likely to be much greater and more widely felt than the costs imposed directly on the owners of and participants in those systems.

    Regulatory agencies must thus supervise financial institutions and critical infrastructures with an eye toward overall financial stability as well as the safety and soundness of each individual institution and system.

    The crisis has demonstrated that a too-narrow focus on the safety and soundness of individual institutions or systems can result in a failure to detect and thwart emerging threats to financial stability that cut across many firms or markets.

    A critical building block of a successful systemic, or macroprudential, approach to supervision is a requirement that all systemically important financial firms be subject to consolidated supervision. The systemic regulator is to be assigned responsibility for overseeing the health of the overall financial system and, recent reforms in UK saw this duty be assigned to the central bank. The path taken is based on the central bank's breadth of expertise and its traditional roles in promoting financial stability and serving as a backstop liquidity provider to the financial system.

    However, giving all macroprudential responsibilities to a single agency risks creating regulatory blind spots, at least--the skills and experience needed to oversee the many parts of the complex financial system are distributed across a number of regulatory agencies. Rather than concentrating all macroprudential authorities in a single agency, it would be wiser that all regulators be required to routinely factor macroprudential considerations into their supervision, thus helping ensure that risks to financial stability can be addressed wherever they arise.

    This in reality is easier said than done, linked article did touch on coordination among regulatory agencies in undertaking the task..

    The challenge arises out of the regulatory styles and approaches unique to prudential regulators and capital market regulators...semua ada bias toward saving own anak under their watch...

    I'm more inclined towards the setting up of an Independent Systemic Risk Regulator or a Council with dedicated team working together with the Central Banks and other Financial Authorities who have an Industry specific Macro Prudential mandates

  2. The key lies in proper mapping of exposures linked via a Single Entity ID either domestically or globally (for cross border), together with proper understanding of inter-market linkages and the relevant risk factors that can pose systemic risks to the system (eg: default, withdrawal etc)

    All of which can be done with the current development of database and telecommunication technology

  3. refer here on the full text by FRB Chair quoted above

  4. Lovely comments, bro. tabik, tabik.

    I won't argue with any of it, except perhaps having an independent regulator. There's pros and cons of course (not least concentration of power), but might not having one agency being responsible for both financial stability and economic stability make as much sense? Even with blind spots, there's something to be said for having a centralised look at both at once.

    I'm thinking of a situation where perhaps the central bank, with a mandate for only price stability and economic growth, might act in a way that destabilises the financial system e.g. the Fed's loose monetary policy in 2002-2004.