History of Netherlands Central Bank and future outlook for central banks (which is highly confused)…

A really nice speech by Klaas Knot head of De Nederlandsche Bank, the central bank for Dutchland.

The speech is given celebrating 200 years of the bank, so there is some history to it. Knot then also looks at the future outlook for central banks in future. How DNB evolved from being a sleeping old lady to guardian of the gilder is an interesting story which I guess is common across most central banks.

He says neglect of financial stability as a goal is coming to haunt central bankers. After all the original purpose for most central banks was fin stability which then moved to price stability. With FS, there are two issues:

This is a relevant question for us, central bankers, given two well-known pitfalls we have to avoid as monetary policy-makers. The first pitfall is reacting too late. During the interwar years, for instance, central banks in the major economies were “prisoners” of their own economic orthodoxies and so made mistake after mistake. My institution, too, was dogmatic in believing in the benefits of the gold standard, even in the face of the huge losses due to the devaluation of the British pound.

The second pitfall is that we’re so afraid of reacting too late, that we respond too soon. How can we avoid both these traps? 

I believe there are two preconditions that we must meet. First, we should protect the independence of central banks in monetary policy matters, in all circumstances…..

 The second precondition to stay clear off the pitfalls of either reacting too late or too soon, is that we must never forget that central banks are very exceptional institutions. Because of their ability to lend and so to create liquidity for banks.In normal times, this may just mean day-to-day management of liquidity in the financial system. But in times of financial stress, as we’ve seen in recent years, it may mean having to act as lender of last resort.

Before the crisis, central banks were as independent as one could imagine. But did that help? More important is to not get trapped in narrowly focused goals which most of these organisations were trapped in.

Clearly, the crisis has led to several issues ahead for central banks. The lessons:

I would say it has. Let me explain that by looking with you at three major lessons that the crisis has taught us. Three lessons that have challenged the pre-crisis consensus on what central banking was about.

The first lesson. The crisis has reminded us that price stability alone is not enough to ensure macro-economic and financial stability. By now it’s therefore become widely accepted that the pre-crisis view of central banking, which was based on central banks focusing mainly on price stability, was too narrow. Or, to quote Willem Buiter, “the financial stability role of central banks has returned with a vengeance”.

The second lesson. The crisis has shown us that central banks are on the front line when the financial system comes under stress. This has fed arguments in favour of entrusting central banks with the prudential supervision of financial institutions…..

The third lesson. The crisis has also taught us that price stability alone is not enough to ensure financial stability. And that adopting a micro-prudential perspective does not suffice either. We know that the key factors in the crisis were the links between various financial players, and the links between financial institutions and sovereigns. And so we are aware of the need to also have a macro-prudential perspective as well.

These lessons lead to several qs:

  •  What are the implications for monetary policy strategy of incorporating financial stability risks?
  • How should we deal with the interactions between macro-prudential policy and monetary policy and between monetary policy and supervision of banks?
  • How can central banks contribute to cross-border payment cooperation and ensure level playing fields without discouraging competition and without creating undue uncertainty about regulations?
  • And above all, and this is very important in my view, how are we to deal with the major institutional challenges of bringing these core functions of central banks closer together and preserving the synergies between them?

Luckily, these are some of the very questions that you’re here to discuss today and tomorrow. But these are also questions that are not easily answered. For there are several concerns that we need to take into account:

  • – For one, giving central banks a larger role in financial stability may blur the lines between different policies.
  • – And the fact that financial stability involves so many different actors, makes things even more complicated.
  • – Also: central banks may end up becoming more political than they were in the decades before the crisis.
  • – And this, of course, will then give rise to a legitimate concern about a possible democratic deficit.
  • The all-important question, therefore, is: How we can preserve our independence with regard to price stability, while at the same time broadening our responsibilities?

All over the place really..

One has to stop and say even to needlessly repeat each time – there has been way too much focus on central banks over the years. We should have focused on what other institutions are doing and other parts of economy doing (other than fin markets). One realises the real economy issues were cropping up even in advanced economies but were largely ignored. One believed central banks and financial markets can absolve us of all the possible economics sins. Worse is the focus continues and just gets messier.

The hype around central bank appointments and expecting miracles has been blown to the top. We thought great moderation was a miracle driven by central banks but has fallen flat. And this is part of central bank history too. They collectively bring us to a problem and then discuss ways to get out of it. The enormous attention given them this feeling of demi-gods who can do no wrong. The reality of course is very different.

One Response to “History of Netherlands Central Bank and future outlook for central banks (which is highly confused)…”

  1. William Adams Says:

    Congratulation to DNB for completing 200 year. Its really a great achievement.

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