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S. Balakrishnan

Jackson Hole is the annual gathering of central bankers, hosted by the Federal Reserve Bank of Kansas, one of the several regional arms of the US Federal Reserve. It is always a much looked-forward-to event for its insightful papers, presentations and debates. This year is no exception.

The conference took place in far calmer waters than last year, when the world economy, financial institutions and markets faced their worst crisis. Central banks rose up to the occasion. All, including the inflation-obsessed European Central Bank slashed interest rates to near zero and supplied as much liquidity as financial institutions and markets demanded. More than anything, it was the latter which averted a total breakdown.

Not that central banks can now rest easy on their laurels. In fact, their challenges may just be beginning. It wouldn’t be an exaggeration to say that a major and critical re-examination of the responsibilities of central banks is under way.

For, before the crisis, it seemed there was a complete consensus on the mandate of central banks — keeping inflation low and stable and to do whatever that takes. Whether inflation management must include the possible effects of rising asset prices did cause differences, with the US coming down squarely on the side of benign neglect.

The consequences are there for all to see.

But the biggest implication of the crisis is that central banks cannot be idle spectators of institutions and markets. Their functions must include financial system oversight – going much beyond just ivory tower talk on only inflation target-guided monetary policy.

What are the issues that must concern them?

A laundry list could be regulation and supervision of capital, credit standards, types of assets financed, their liquidity, leverage and quality of investments.

One of the things they must come to grips with is the overwhelming predominance of financial assets — bonds, securitisations, currencies and derivatives — either as themselves or collateral in the balance sheets of global banks. Their price volatility is considerable, risking sudden, entirely unanticipated collapses of large investment and lending institutions.

Thus, central banks can no longer confine themselves to the narrow path of monetary rectitude and hope they have done their job.

On the contrary, they might, sometimes be required to — horror of horrors — substitute for commercial banks when normality breaks down, as it has now, disregarding their own canons of monetary policy. Equally difficult is timing the exit from such interventions.

There’s no doubt central banks will continue to occupy centre stage, as opposed to Governments.

The growth of financial leviathans and behemoths, which essentially control global capital flows, means their responsibilities are more important and critical than ever.

More Stories on : RBI & Other Central Banks | Financial Scan

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