Über die Autorin bzw. den Autor

Howard Davies is director of the London School of Economics and Political Science. Previously, he was chairman of the United Kingdom's Financial Services Authority and deputy governor of the Bank of England. David Green has worked for almost forty years as a central banker and financial regulator, principally at the Bank of England and the Financial Services Authority. Davies and Green are the authors of Global Financial Regulation.

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"Not long ago, national central banks were endowed with wide-ranging authority, enormous prestige, and a high degree of independence. Today, in the aftermath of the global financial crisis, rethinking their functioning and their modus operandi is both natural and needed. Howard Davies and David Green write on this issue with authority, reflecting their practical experience, political sensitivity, and high analytic skills."--Paul Volcker, former chairman of the U.S. Federal Reserve and current chairman of the U.S. Economic Recovery Advisory Board

"Banking on the Future provides the most comprehensive and lucid analysis of the pressing challenges faced by central banks. The book clearly shows how monetary policy and financial stability concerns have drifted apart in recent years and the crucial role this dichotomy has played in the run up to the crisis. Davies and Green put forward precise, cogent, and practical recommendations for the future. It is urgent and important that policymakers ponder and act on these proposals."--Jacques de Larosière, chairman of the Strategic Committee of the French Treasury and former governor of the Banque de France

"An indispensable book for practitioners and students alike. The authors write from a depth of central banking experience, and have witnessed at close hand the disastrous consequences of separating monetary policy from financial regulation. They provide a convincing plan for reuniting the two."--William Keegan, senior economics commentator,Observer

"The great credit crisis of 2007-9 begs the question: how much do we need to rethink central banking? The explosive issues include whether central banks should lean against asset bubbles, whether inflation targeting needs to be reconsidered, and whether strong independence is compatible with the expanding responsibilities assumed by central banks. There is no one more reliable than Davies and Green for guiding us through this minefield."--Barry Eichengreen, author ofThe European Economy since 1945

"An extraordinary book that asks all the right and very difficult questions, and manages to suggest some of the answers."--Guido Tabellini, Università Commerciale Luigi Bocconi, Milan

"This is a timely book on an important subject. It represents a significant contribution to the literature on central banking, and draws on historical, political, economic, business, and sociological considerations."--Rosa M. Lastra, Centre for Commercial Law Studies, Queen Mary University of London

"In the wake of recent financial disturbances, there have been many papers and books on what went wrong, and on what changes there have to be in the private financial sector and the behavior of regulators. There has, however, been very little written on the implications for central banks. This is an excellent, clear, and important book."--Geoffrey E. Wood, Cass Business School, City University London

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"Not long ago, national central banks were endowed with wide-ranging authority, enormous prestige, and a high degree of independence. Today, in the aftermath of the global financial crisis, rethinking their functioning and their modus operandi is both natural and needed. Howard Davies and David Green write on this issue with authority, reflecting their practical experience, political sensitivity, and high analytic skills."--Paul Volcker, former chairman of the U.S. Federal Reserve and current chairman of the U.S. Economic Recovery Advisory Board

"Banking on the Future provides the most comprehensive and lucid analysis of the pressing challenges faced by central banks. The book clearly shows how monetary policy and financial stability concerns have drifted apart in recent years and the crucial role this dichotomy has played in the run up to the crisis. Davies and Green put forward precise, cogent, and practical recommendations for the future. It is urgent and important that policymakers ponder and act on these proposals."--Jacques de Larosière, chairman of the Strategic Committee of the French Treasury and former governor of the Banque de France

"An indispensable book for practitioners and students alike. The authors write from a depth of central banking experience, and have witnessed at close hand the disastrous consequences of separating monetary policy from financial regulation. They provide a convincing plan for reuniting the two."--William Keegan, senior economics commentator,Observer

"The great credit crisis of 2007-9 begs the question: how much do we need to rethink central banking? The explosive issues include whether central banks should lean against asset bubbles, whether inflation targeting needs to be reconsidered, and whether strong independence is compatible with the expanding responsibilities assumed by central banks. There is no one more reliable than Davies and Green for guiding us through this minefield."--Barry Eichengreen, author ofThe European Economy since 1945

"An extraordinary book that asks all the right and very difficult questions, and manages to suggest some of the answers."--Guido Tabellini, Università Commerciale Luigi Bocconi, Milan

"This is a timely book on an important subject. It represents a significant contribution to the literature on central banking, and draws on historical, political, economic, business, and sociological considerations."--Rosa M. Lastra, Centre for Commercial Law Studies, Queen Mary University of London

"In the wake of recent financial disturbances, there have been many papers and books on what went wrong, and on what changes there have to be in the private financial sector and the behavior of regulators. There has, however, been very little written on the implications for central banks. This is an excellent, clear, and important book."--Geoffrey E. Wood, Cass Business School, City University London

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Banking on the Future

PRINCETON UNIVERSITY PRESS

Contents

Preface...........................................................................viiAbbreviations.....................................................................ixIntroduction......................................................................1Chapter One What Is Central Banking and Why Is It Important?.....................9Chapter Two Monetary Stability...................................................23Chapter Three Financial Stability................................................52Chapter Four Financial Infrastructure............................................90Chapter Five Asset Prices........................................................115Chapter Six Structure, Status, and Accountability................................141Chapter Seven Europe: A Special Case.............................................182Chapter Eight Central Banking in Emerging Market Countries.......................212Chapter Nine Financial Resources, Costs, and Efficiency..........................236Chapter Ten International Cooperation............................................252Chapter Eleven Leadership........................................................270Chapter Twelve An Agenda for Change..............................................285Afterword.........................................................................297Notes.............................................................................301Index.............................................................................317

Chapter One

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 1930s-or that other payment mechanisms break down so that goods and services can only be traded through barter. That tends to happen only in wartime, as in Afghanistan in the recent past or, briefly, when Iraq invaded Kuwait in 1991 and no one knew who controlled the Kuwaiti central bank.

It is more common for individual banks or other financial firms to fail. Banking is itself a fragile business because a bank depends on the confidence of its depositors that it will be able to repay their deposits whenever they want them, even though it has lent them out at longer terms to borrowers. The maturity transformation that banks carry out is in that sense a confidence trick.

All developed economic activity is dependent on this fragile financial infrastructure, which requires its numerous constituent players to play their parts as expected: the provider of currency must avoid issuing it at such a pace that it is devalued; those making payments must deliver them to the intended recipient ; savings should be made available to sustain investment and loans provided to sustain business activity, house purchase, or consumer spending.

Society looks to central banks to try to prevent these inherent fragilities crystallizing or, if they do, to mitigate their repercussions. The instruments at their disposal are quite limited and, in a sense, not very sophisticated. Their main tool is their own balance sheet, as it is by acquiring and selling assets and liabilities, borrowing and lending, that they can seek to influence prices and interest rates in other markets. The effectiveness of these actions is far from guaranteed-indeed the central bank's own balance sheet may well be constrained-and is dependent on the wider economic climate in which they are operating. So the use of the balance sheet has to be supplemented by suasion or guidance to the markets and to economic agents generally. Indeed it may be as much through persuasion as through economic action that a central bank achieves its aims. The combination of the two determines whether what the central bank does makes any difference at all, given that its armory of tools is essentially very limited. Changes in its balance sheet may be backed up by an array of other controls, for which it may be responsible, on the behavior of economic agents. These may be capital or exchange controls, or controls on bank behavior, such as quantitative or price controls. But in open markets such controls are of limited value in the long term.

Because the economic environment changes constantly, the way the tools are used evolves. Political priorities change over time, sometimes quite markedly and rapidly, with switches, even within a single country, from ensuring credit is available to favored economic sectors to restraining inflation, and then, perhaps, to maintaining a particular exchange rate.

Almost all countries now boast an institution called a central bank. Central banking was not always so widespread, nor were its advantages so widely acknowledged. In the United States, there were two unsuccessful attempts to establish a "central" bank, in both cases called the Bank of the United States, before the Federal Reserve System was set up in 1913. There was a strong strand of thinking in the United States at the time in favor of "free banking," and a fully competitive banking system, without the intermediation of a state-owned or state-backed institution at its center. Indeed, arguments about the merits of free banking still rumble on in some academic and political circles.

Advocates of free banking argue that private monetary systems have in the past been stable and successful, and that a competitive banking system is less susceptible to bank runs, while the existence of central banks has allowed political interference in the banking system, which has had the effect of altering incentive structures and which has created instability. These arguments have not, however, persuaded many governments. The balance of evidence appears to show that free banking leads, instead, to systemic instability. So while arguments continue about the sources of financial instability and, while even before the financial meltdown of 2007-9, the incidence of banking crises remained surprisingly high, both the academic and the political debates now focus more on the appropriate functions and responsibilities of the central bank rather than on whether it should exist at all.

But what exactly do we mean by a central bank? The answer is not straightforward. Indeed the definition of the functions that are appropriate for a central bank has changed considerably through time. As the BIS Central Bank Governance Group points out, in the past central banks "have been understood more in terms of their functions than their objectives."

Historians of monetary institutions tend to date the introduction of central banking to the foundation of the Swedish Riksbank in 1668 or to the foundation of the Bank of England in 1694. But, as Capie et al. point out, at that time there was no developed concept of central banking. The Bank of England was founded as a private bank to finance a war. Not...