What are central banks for?

Posted by: Paul Donovan

01 May 2020

Weekly Update

  • The world is used to central bankers being economic superheroes. Normally an economic downturn is caused by an imbalance. It might be a housing bubble or excessive credit. It could be a current account crisis. The imbalance creates an economic downturn. The central bank balances the imbalance. The recovery can begin.
  • This downturn is nothing like that. This is not a downturn caused by imbalances. The path of the recovery is not likely to follow the imbalance‚ÄĒrebalance route. Central banks cannot play the same role that they have done in the past. It is fiscal policy that needs to support the economy.
  • So what are central banks supposed to do? There are three roles. Central banks need to match any increase in demand for cash. Central banks are the monopoly suppliers of cash. Central banks need to make sure that banks are able to lend. That may require changing regulatory guidance. No one wants a credit crunch on top of everything else. Finally, central banks need to make sure that governments can finance fiscal policy. That means ensuring bond markets are stable.
  • In this downturn, central bankers are not superheroes. They are cheerleaders for fiscal policy. It is time to start waving the pom-poms.

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