Reassessing Central Banking

The Challenge

The Great Recession of 2008–09 has cast doubt on the broad consensus among economists and policy-makers that inflation targeting by central banks leads to desirable macroeconomic outcomes. Indeed, many analysts suggest that the loose monetary policy stance of the US Federal Reserve was one of the main causes of the financial crisis and the economic downturn that followed.		(Please click to enlarge)
Before the crisis, most central banks focused on low and stable consumer price inflation and used short-term interest rates as the main tool to implement their inflation target. Monetary aggregates and the supervision of other prices (such as asset prices) usually played a minor role in the conduct of monetary policy.
While most central banks had a role in monitoring risks to the financial system, they typically shared responsibilities for banking supervision with other government bodies. Will central banking be the same after the Great Recession? Should there be more than one pillar to central banks’ strategy—a focus on financial stability as well as price stability? And if they are to play a bigger role in monitoring systemic risk, what are the potential tensions between traditional monetary policy and banking supervision?

Proposed Solutions