Thursday, February 24, 2011

More on redefining the role of central banking

This is carrying forward from my earlier blog post on the re-definition of the role of central bankers. The Economist has an interesting debate on the issue. Its Economists by invitation column recently discussed the changing role of central banks.

John Makin and Michael Bordo argue that central banks return to a focus on their primary goal of maintaining price stability. They also advocate a separation of price and financial stability functions.

Hyun Song Shin argues that the big failure of the pre-crisis monetary policy was a neglect of the macroeconomic importance of financial stability. He writes that the central banks either hived off the "unglamorous business of financial stability" to a separate microprudential regulator or neglected it. The central bankers sought to specialize in the technical details of core monetary policy.

Markus Brunnermeier advocates that central banks should use more of the available tools to maintain financial stability. He also suggests that "central banks should lean against imbalances preventively", instead of just cleaning up after crisis strikes. Takatoshi Ito impresses on the importance of central banks to coordinate closely with fiscal and regulatory authorities in managing the financial markets and during crisis management.

Avinash Persaud feels that the effective divorce (in many countries) between central bank and regulatory agency, or monetary policy and regulatory policy, was a fatal mistake. He writes, "Monetary policy was deliberately oblivious to the asset price boom — that was somebody else’s problem. Regulatory policy was oblivious to macro risks — that was the central bankers job."

An excellent article in the same magazine chronicles the changing face of central banking and examines the dilemmas facing central bankers in the post-sub-prime crisis era. One of the concerns that was raised relate to the perception that, with quantitative easing, central bankers are treading into fiscal policy. In particular there are influential voices that claim that central bank purchases of government bonds, in the hope of lowering long-term interest rates, are tantamount to fiscal policy. They also argue that such policies were responsible for generating and sustainaing several macroeconomic imbalances in the global economy. Further, they also contend that such policies also end up bailing out greedy and irresponsible bankers.

In addition to the issues discussed in the earlier post, there are growing voices that central banks should take on more responsibility for the supervision of banks, especially with respect to the stability of financial systems. This effectively means more macro-prudential regulation, in addition to their existing responsibility for micro-prudential (bank-specific) regulation. This would involve assessing the systemic risk of the actions of individual institutions and different financial instruments.

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