Re-imagining Central Banking

Abstract

Why does central banking need to be re-imagined? The urgency of the task obviously arises from the experience of the global financial crisis, during which central banks intervened in dramatically new ways and to a dramatically greater degree than ever before, at least in peacetime. Central banks invented new tools on the fly, because the familiar old tools were not working. Now the crisis is over comes the important intellectual task of understanding how these new things fit within the standard pre-crisis toolkit. Just so, Borio and Disyatat (2009) distinguish between the old "interest rate policy" and the new "balance sheet policy", urging us to understand the latter as, on the one hand, nothing more than an extension of traditional techniques of FX intervention to a broader asset class and, on the other hand, nothing less than use of the central bank balance sheet to implement debt management policy that is more traditionally undertaken by the Treasury. The present paper can in part be understood as a critical but sympathetic reconsideration of this early appraisal. But the challenge of re-imagining central banking is not just because of the crisis. In retrospect, the crisis can be viewed as the first full-fledged test of the emergent system of financial globalization, which had been building bit by bit for three decades at least. The "financial" dimension of this construction has involved ever-increasing integration of capital markets with money markets; so-called "shadow banking", which is to say money market funding of capital market lending, is the quintessential institutional form of this new construction (Mehrling et al., 2013). Meanwhile, the "globalization" dimension has involved ever-increasing integration of funding markets across the face of the globe with the central dollar funding market. Not only is the dollar the world reserve currency , but the dollar money market is also the world funding market, and the dollar money market is linked to all other funding markets through the foreign exchange markets, all of which are backstopped to varying degrees by national central banks (Mehrling 2013). Either of these developments alone would have warranted re-imagining central banking, even in the absence of any crisis. 163