A changing financial system
Warwick Business School
wbs.ac.uk
Sometimes one has to run fast just to stand still. The financial system is continually evolving as we all change our habits. Central banking has to evolve to reflect changes in people’s behaviours, in particular how that impacts on financial markets. Over the past 15 years, and in the face of low inflationary pressures and interest rates close to, or even below, zero, many developed country central banks have loosened monetary policy through expansion of their balance sheets. Now they face the prospect of reversing that expansion.
But no one knows what an optimal balance sheet looks like for a central bank: How big should the balance sheet be? What assets should be held? Who should be entitled to bank with or borrow from the central bank? If transactions move outside the banking system – to capital markets and shadow banks - how can financial stability best be maintained? How should the authorities respond to financial failures? These and many other questions are challenging the concept of what a central bank is, what its responsibilities are, and how it operates each in its own domestic economic and political environment. One thing is certain – the actions of central banks have an increasingly important and sometimes dominant influence on the financial system and hence the wider economy on which we all depend.
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