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Rethinking Central Banking In The 21st Century

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Some Advice from an Ex-central Banker

Central banking has experienced a tremendous change in the last three decades. From “behind the scene” secretive rulers of the world (the Plaza Accord of in 1985), to the period of great moderation, attributed to monetary policy, when central banking was called “boring” (until 2007), to the recent almost celebrity status of some central banks and governors.

Truth to be told, some past governors are considered as causes of economic troubles and some that are in office nowadays are looked up to like modern day saviours, expected to pull out the latest trick out of their sleeves to save the economy.

First, where does the criticism of central banking come from? At the end of 2011 (the time of writing) the world economy is still in a deep financial, economic and structural crisis and more volatility lies ahead. The economic profession is unable to clearly identify its causes, but various narratives float around.

Some of them “blame” central banks for the mess we are in. Some see the causes of our problems in the neoliberal approach to economics and, more specifically, in the so-called light-touch financial regulation often done by central banks (which was highly praised only a couple of years ago). Some are more specific and point out the “Greenspan put” in particular and too loose monetary policy with low interest rates, especially after the 2002 bubble burst, which according to this narrative created the new, real estate bubbles, starting in the US and then spilling over to the rest of the world. Others blame financial innovation and, in particular, derivatives (“financial weapons of mass destruction”, as Warren Buffet called them). Some say it was greedy bankers and their skewed incentive/ bonus structure (which can be described as “head I win, tail you lose”) and regulators/central banks that did not stop them. And of course, there is an almost infinite variety of any linear combination of the mentioned factors (plus other ones). The “inconvenient truth” for the economic profession is that: a) we do not know for sure what the causes of the crisis are and b) central banking is often mentioned as a cause of the troubles. Others look at central banks as the last hope to save the world from a complete meltdown.

The aim of this note is neither to judge the past nor to offer a clear look into the future. It is too early to make qualified judgments on the past, and rethinking the future of central banking will take a lot of collective effort from experts in this area. This note intends to give some advice from an ex central banker which might be useful when facing future challenges.

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