Moreover, to the extent that the support offered by asset purchases represents the offer of the central bank’s balance sheet as an alternative venue for intermediation when private markets have seized up, it is natural that the asset purchases could be accompanied by asset sales, either in parallel or at least in close proximity. It is by both buying and selling (or alternatively lending and borrowing) that the central bank intermediate financial transactions between private market participants. This is the essence of the central bank acting as a central counterparty or market maker of last resort. Bank of England  Page 11  Relationship with financial stability There is also a natural complementarity between providing central bank support to maintain market functioning and contributing to the maintenance of financial stability. Indeed, the two go hand‐in‐hand. The direction of support will depend upon the specific incidence of market failure causing market dysfunction, the structure of the financial system, and the broader flexibility of the economy. This is the essence of why such interventions will be ‘targeted’ on specific market segments. These factors will vary both over time and from one jurisdiction to another. The form of support offered by central banks will thus also vary. Yet central banks must also recognize the limitations of their policy. In the face of crisis, they may need to be innovative in their approach. But central banks should be very wary of assuming responsibility for goals that they do not have the instruments to pursue.
As is well known, the long lags of policy creates a need for central banks to “take the punch bowl away when the party gets going”. Given the longer duration of financial cycles, the need to act well before the risks become obvious may mean that central banks will have to “take the punch bowl away even before the party gets started”. But that is a political economy challenge that needs to be resolved and managed through careful redesign of central bank mandates. Heed must be paid also to institutional arrangements, especially for central banks where the financial supervision authority lies with another body as coordination will be harder. This will take time. But the risks to financial stability is immediate. In the interim, central banks may need to interpret their mandates more flexibly and avoid overly narrow and zealous interpretations of price stability. Inflation targets need to be implemented flexibly and over longer horizons. All the while explaining clearly and consistently the logic of policy. In doing so, it should be stressed that fundamentally, macroeconomic and financial stability are two sides of the same coin. Macroeconomic trajectories cannot be sustainable 9  if the financial sphere is out of equilibrium. And the avoidance of financial boom-bust cycles leads to better economic outcomes over the long run. The perceived trade-off between growth, inflation, and financial stability, therefore, is to a large extent an artifact of the short horizon focus of policy.