by Don Alexander, MBA
Associate, RSD Solutions Inc.
The global financial crisis has shaken the foundations of the deceptively comfortable pre-crisis banking world. Central banks face a threefold challenge: economic, intellectual and institutional. Claudio Borio in a paper for the Bank of International Settlements, notes the changing environment that central bankers face going forward; operating in a more hostile economic environment, the current economic benchmarks paradigms and models have failed and central banks will need to adjust their policy framework to maintain their independence.
Policymakers will look for a new compass that should have the following characteristics: (1) tight interdependence between monetary and financial stability; (2) a greater awareness of the global, as opposed to purely domestic, dimensions of those tasks; and (3) the autonomy of central banks will need to be protected and strengthened.
Borio notes three lessons that central banks learned from the crisis. The first is that low and stable inflation does not guarantee financial and macroeconomic stability: monetary policy may have contributed to the crisis’s severity. This is especially true during a period of prolonged easing. The use of monetary policy to clean the post-crisis debris can be costly. Interest-rate policy may not the right policy tool for the nature of the crisis: it is not optimal during a balance sheet recession. There are times when a disagreement on policy may be as good as consensus.
Borio proposes the compass include adjustment to policy regimes, including the tighter integration of monetary policy and financial stability, adjustment for financial imbalances, consideration of monetary policy response to financial busts, the operational independence of central banks and a keener awareness of the global dimensions of these tasks.
The key challenges for the implementation of the compass: the operational independence of central banks is likely to come under growing pressure and the need for greater international policy coordination. A compass for central banks is needed as they sail into uncharted waters.
Please see the attached link for more details. http://www.bis.org/publ/work353.htm
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