Outlines of the medium run for central banking

Daniel H. Neilson

The five years following the global finanancial crisis of 2007 have been a period of change for central bank policy-making. The Fed shifted its target from the Fed Funds rate to balance-sheet quantities. The ECB found its monetary union sorely tested, and was reluctantly brought about to addressing internal imbalances. The BoJ is attempting to jawbone inflation. The PBoC is trying to forestall a ma jor credit crisis. In each case, the realignments of the global financial system of the last five years can be seen to have necessitated a shift in the central bank’s stance vis-a-vis government and the private sector.

Focus appeared to shift from output and price stability to financial stability. The activity of each of these central banks is best understood through the evolution of the stock quantities on its balance sheet and the flows consistent with this evolution. So articulated, each bank can be viewed as opposing, each in its own way, what Hawtrey called the “inherent instability of credit”—essentially, the procyclicality of the quantity and price of credit. There is much talk of “exit strategy”, and to some extent this sense of finality is warranted. The Fed’s crisis-time special liquidity facilities, for example, are already closed. At some point, overnight interest rates are certain to rise from zero. However, the term also implies that the pre-crisis norm
can be restored. This is incorrect; in substantial ways the credit environment is different from that of 2007. There is also much talk of a “new normal”. This view is largely unwarranted. What is emerging is unlikely to remain static for long.

I will discuss some decidedly modest predictions that arise from these views, and make some proposals regarding the treatment of central banks within the stock–flow consistent modeling approach.