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Banking on the Future

Banking on the Future: The Fall and Rise of Central Banking

Howard Davies
David Green
Copyright Date: 2010
Pages: 320
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  • Book Info
    Banking on the Future
    Book Description:

    The crash of 2008 revealed that the world's central banks had failed to offset the financial imbalances that led to the crisis, and lacked the tools to respond effectively. What lessons should central banks learn from the experience, and how, in a global financial system, should cooperation between them be enhanced?Banking on the Futureprovides a fascinating insider's look into how central banks have evolved and why they are critical to the functioning of market economies. The book asks whether, in light of the recent economic fallout, the central banking model needs radical reform.

    Supported by interviews with leading central bankers from around the world, and informed by the latest academic research,Banking on the Futureconsiders such current issues as the place of asset prices and credit growth in anti-inflation policy, the appropriate role for central banks in banking supervision, the ways in which central banks provide liquidity to markets, the efficiency and cost-effectiveness of central banks, the culture and individuals working in these institutions, as well as the particular issues facing emerging markets and Islamic finance. Howard Davies and David Green set out detailed policy recommendations, including a reformulation of monetary policy, better metrics for financial stability, closer links with regulators, and a stronger emphasis on international cooperation.

    Exploring a crucial sector of the global economic system,Banking on the Futureoffers new ideas for restoring financial strength to the foundations of central banking.

    eISBN: 978-1-4008-3463-1
    Subjects: Finance, Business

Table of Contents

  1. Front Matter
    (pp. i-iv)
  2. Table of Contents
    (pp. v-vi)
  3. Preface
    (pp. vii-viii)
  4. Abbreviations
    (pp. ix-xii)
  5. Introduction
    (pp. 1-8)

    The global credit crisis that began in the summer of 2007 threw a large rock into the calm waters of central banking. Though many commentators, and indeed some central bankers themselves, had for some time been drawing attention to the risks posed for financial stability by global imbalances, surging credit, and liquidity, and narrowing risk spreads, when the crisis hit in August 2007 the speed and severity came as a surprise, not least to central bankers.

    The proximate causes of the crisis lay in securitizations based on the subprime mortgage market in the United States, but the first serious signs...

  6. CHAPTER ONE What Is Central Banking and Why Is It Important?
    (pp. 9-22)

    Societies become so used to the availability of stable currency, the ability to make payments both domestically and internationally, and the existence of banks and other financial institutions through which to save and borrow that it is easy to forget that each of these is a purely social construct, fundamentally based on trust, albeit bolstered by legislation. Occasionally, unpleasant reminders resurface abruptly that the financial system is fundamentally fragile. It is rare, fortunately, that currencies lose their value so fast that they cease to function—something that we have recently seen in Zimbabwe and that happened in Germany in the...

  7. CHAPTER TWO Monetary Stability
    (pp. 23-51)

    Central banks are active in three areas in which stability has been seen as a desirable goal of public policy. The three areas are interdependent, but they have sometimes been seen as separate in analytical terms, as well as distinct objectives of policy. They may or may not be primarily assigned to the central bank as its special responsibility. Sometimes other agencies in government are, nominally at least, entrusted with the lead role.

    The three areas are:

    domestic price stability, or monetary stability;

    external stability, or exchange rate management; and

    stability in the financial system.

    These days, few question the...

  8. CHAPTER THREE Financial Stability
    (pp. 52-89)

    The financial disasters of 2007–9 brought the role of central banks in financial markets back into sharp focus, after a period in which a narrow price stability objective had held pride of place. The authorities were unclear how to react when the crisis began in the summer of 2007, and were again wrong-footed by the meltdown in the fall of 2008, following the failure of Lehman Brothers. It was widely argued that there was a need for a fundamental rethink of how central banks monitor trends in financial markets, how they provide liquidity and other forms of support to...

  9. CHAPTER FOUR Financial Infrastructure
    (pp. 90-114)

    Whether or not they have the statutory responsibility for banking supervision, central banks play the key role in the day-to-day functioning of the financial system. They are, almost everywhere, the authorities empowered to provide liquidity to the banking system. They are also often the overseers of payment systems, and the linked settlement systems for securities and foreign exchange. Sometimes they manage government debt, though the practice has become less widespread in recent years. In each case, the crisis has challenged previous assumptions about the responsibilities that central banks should have in these areas, and how they should carry them out....

  10. CHAPTER FIVE Asset Prices
    (pp. 115-140)

    Perhaps the fiercest controversy in the world of central banking in the last few years has centered on the extent to which monetary policy should respond to changes in asset prices—whether equities, property, or, most particularly, housing. The arguments for and against doing so rumbled on through the early years of the century, in Basel, the IMF, and the scholarly journals, and burst into the open in late 2007, as the severity of the credit crisis began to be understood. The issue lies at the heart of the critique of central banking in the Greenspan years, which has now...

  11. CHAPTER SIX Structure, Status, and Accountability
    (pp. 141-181)

    The movement toward central bank independence has seemed unstoppable in recent years. In Germany it was a postwar reaction to prewar hyperinflation. Elsewhere it was largely a reaction to bouts of inflation in the 1960s and 1970s. As Cukierman has pointed out, “There is mounting evidence that the legal independence of most central banks in the world has increased during the nineties to an extent that appears to be a veritable revolution in central bank legislation.”¹ In a survey by Fry et al., carried out for the Bank of England in 2000, 71% of banks say they enjoy independence without...

  12. CHAPTER SEVEN Europe: A Special Case
    (pp. 182-211)

    The creation of a monetary union between eleven of the member states of the EU in 1998 was perhaps the most ambitious central banking project ever contemplated. Although countries have shared a common currency before, for instance through the medium of a currency board (as in the East Caribbean and West Africa), the interlinking of central banks on this scale is without precedent, particularly given the complexity of the activities brought together and the different characters of the national central banks, many of them steeped in idiosyncratic historical tradition. By 2009, sixteen countries had joined the euro area (the most...

  13. CHAPTER EIGHT Central Banking in Emerging Market Countries
    (pp. 212-235)

    Central bank governors typically occupy grand premises. The theory is that such premises inspire confidence in the public—though commercial banks have now generally abandoned their own marble halls. The contrast between the grandeur of the central bank and the squalor of the Ministry of Finance is often striking, not least in Japan, where the Ministry is a rabbit warren with officials working a dozen to a room, often sharing desks and even chairs. Before the Treasury’s refurbishment it was similarly true in London, and even now there is no comparison between the Governor’s Parlours and the modest lodging of...

  14. CHAPTER NINE Financial Resources, Costs, and Efficiency
    (pp. 236-251)

    The financial crisis has reminded us that central banking costs money—rather a lot of money if bad decisions are made. It has also reinforced the need for central banks to have the resources to act decisively and quickly when necessary. Of course when solvency support is provided to the banking system, the ultimate guarantor must be the government, and the quality of the government’s credit is the decisive element. The Icelandic case illustrated the fact that where the market doubts the tax capacity of the government, the central bank’s backing for troubled banks is of little value. The quantitative...

  15. CHAPTER TEN International Cooperation
    (pp. 252-269)

    Central bankers are traveling folk. Governors are in the top tiers of every airline’s frequent flyer scheme. Their carbon footprints are among the heaviest around the globe. This is perhaps understandable, given the highly mobile character of international finance and the growing interconnectedness of economies and financial markets, though central bankers make far less use of videoconferencing than do private-sector bodies. We want our central bankers, at the very least, to know what is going on in other countries whose markets affect their own and, where necessary, to coordinate their interventions with those of their counterparts elsewhere. Euro area central...

  16. CHAPTER ELEVEN Leadership
    (pp. 270-284)

    Central bankers often congratulate each other at their frequent international gatherings on how remarkably well they get on together by comparison, say, with their finance ministry colleagues or even their friends in the supervisory world. They believe they think the same way and have the same reactions in the face of a rather hostile, uncomprehending non-central banker world. There is a distinct sense of a central bankers’ club, bound together by a common psyche that seems to transcend differences in history, functions, degrees of independence, size, or importance.

    This attitude has a number of characteristics, which can be seen to...

  17. CHAPTER TWELVE An Agenda for Change
    (pp. 285-296)

    The events of the recent past have brought a sharp reminder of just how much a well-functioning economy is dependent on a stable financial infrastructure and of just how delicate and fragile the financial infrastructure can be. Its stability depends on the preservation of confidence in its different elements, in the internal and external value of the currency, and in the reliability of payment and settlement mechanisms, and on the ability of financial firms to provide, without disruption, intermediation between borrowers and lenders at costs that reasonably reflect risk.

    The authorities, whether central banks or other parts of government, need...

  18. Afterword
    (pp. 297-300)

    The world of central banking does not stand still. Aftershocks following the earthquake continue to strike and the ground is not yet again stable.

    In two respects the debates we outline above have moved on since we completed our draft in summer 2009. There is a growing, though still by no means universal, acceptance that central banks should seek to promote financial stability as well as price stability, and furthermore that there is room for an explicit role for asset prices in a sophisticated monetary policy framework.

    Signs of a shift in the center of gravity of central bank opinion...

  19. Notes
    (pp. 301-316)
  20. Index
    (pp. 317-324)