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Symposium 2012

Proposal - The Future of Central Banking

The Challenge

The global financial crisis has led to a profound rethinking of the consensus on monetary policy. Before the crisis, most monetary economists agreed that "flexible inflation targeting"—in which cent ...

The global financial crisis has led to a profound rethinking of the consensus on monetary policy. Before the crisis, most monetary economists agreed that "flexible inflation targeting"—in which central banks focus on maintaining price stability and stabilizing the output gap—was an appropriate and sufficient mandate for conducting monetary policy. Key assumptions underlying the consensus were that this mandate would automatically lead to financial stability and that the framework of monetary policy could deal with cross-border capital flows.

The future of Central Banking could be summarized as:

i) Despite the current scenario which is impairing their credibility, the Central Banks will remain the most powerful and influential economic institution;

ii) Presently, there is a transition towards the multiple goal approach, which will include financial stability and, possibly, other objectives as well, such as growth and exchange controls. Hopefully, inflation should remain as the main objective;

iii) An important trade-off: the multiple goal policy reduces the effectiveness of the Central Bank’s key role in managing expectations;

iv) There will be an increasing need for additional monetary instruments over and above interest rates, reserve requirements and rediscount lines. The new focus will be geared towards the nature of credit expansion and asset prices which are leading indicators of potential crisis;

v) The anti-cyclical role and intervention tools will be enhanced during the recessionary phase of the economic cycle. At this stage, some heterodox bias, hopefully of a temporary nature, should be of no surprise;

vi) Greater integration between the roles of Monetary Authority and Supervision should be expected, as well as more emphasis in pre-emptive actions that may reduce the high costs of financial crisis;

vii) The CBs will gradually become more global, both in terms of an orchestrated action as well as in relation to internalizing the externalities of their domestic policies;

viii) This evolution process may result in the transformation of the BIS in something with a similar structure of a World Monetary Authority (WMA) which will coordinate the policy decisions of the different Central Banks and implement across the board regulations;

ix) Although the notion of a World Monetary Authority is difficult to conceive in the present time, it is a natural consequence of the expected unfolding of the economic and financial integration worldwide;

x) It would be the monetary counterpart of the transition from the GATT to the World Trade Organization (WTO). The WMA will be more capable of avoiding “exchange wars” and global financial distress.

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