New facilities were introduced that extended liquidity for longer durations against expanded sets of collateral (public and private) to new counterparties (bank and non-bank). This took last-resort lending to a new level. Some central banks went one step further, becoming effective market-makers of last resort in some assets to secure market liquidity. These were new and bold steps. A fourth dimension was transparency. With monetary, regulatory and operational policies all working in overdrive, central banks have had plenty of explaining to do. During the crisis, their actions have shaped the behaviour of pretty much every financial market and institution on the planet. So central banks’ words resonate as never previously. Rarely a day passes without a forensic media and market dissection of some central bank comment. These, too, are significant steps to have climbed. Where does this leave central banks today? We are not in Kansas any more. On monetary policy, we have gone from setting short safe rates to shaping rates of return on longer-term and wider classes of assets. On regulation, central banks have gone from spectator to player, with some granted micro-prudential as well as macro-prudential regulatory responsibilities. On operational matters, central banks have gone from market-watcher to market-shaper and market-maker across a broad class of assets and counterparties. On transparency, we have gone from blushing introvert to blooming extrovert. In short, central banks are essentially unrecognisable from a quarter of a century ago. Up or down? The key question, then, is where next?
The focus of monetary policy, at least in the 25 years prior to the crisis, had been on controlling the short-term safe rate of interest. Crisisinduced monetary interventions widened that focus significantly. By pursuing QE and forward guidance, central banks began to exercise influence beyond overnight rates of interest. And for those central banks that engaged in credit easing, this influence extended further, from safe to risky rates of return across a broad spectrum of assets. These were giant steps. A second aspect of the reinvention was macro-prudential regulation. Inflation-targeting was necessary but, by itself, insufficient to curb the financial cycle. The response of governments has been to grant central banks new powers, focused on the needs of the financial system as a whole and towards the needs of the nonfinancial economy, as much as the financial sector. That is what the “macro” in macro-prudential meant. Macro-prudential policy is gaining ground every bit as quickly as central bank independence did in the 1990s. It has quite radical implications. Pre-crisis credit cycles were allowed to operate largely unconstrained. Macro-prudential policy overturns that orthodoxy, with policy instead leaning against the credit cycle to moderate its fluctuations, both during the upswing and the downswing. It, too, is a big step forward. A third aspect of the reinvention is in the operations of central banks. During the crisis, central banks flexed their balance sheets as never before.