Seeing Double at Central Banks

OXFORD – Central banks are now targeting liquidity, not just inflation. The credit boom of the past decade highlighted the inadequacy of focusing only on prices, and underscored the need for the monetary authority of a country (or group of countries in the case of the European Central Bank and the eurozone) to monitor the financial sector. Macroprudential regulation is the new term of art among central bankers, supplementing their well-established inflation-targeting regimes.

This shift in focus could radically change monetary policy, but for better or worse? The Bank of England may be blazing the way in this transition, but the ECB and the United States Federal Reserve Board are taking on more financial regulation as well. Indeed, the ECB’s European Systemic Risk Board serves a function that is similar to the United Kingdom’s new Financial Policy Committee (FPC).

At the end of a recent discussion with Andy Haldane, the Bank of England’s Executive Director for Financial Stability and a member of the FPC, I asked: What happens if inflation is high and lending is low? Under this scenario, the Bank of England’s Monetary Policy Committee (MPC) would favor an increase in interest rates, while the FPC would want to loosen monetary conditions.

I am still pondering the question that I posed to Haldane, because the potential for such contradictory policy imperatives appears unavoidable – never more so than now.