Modern Central Bank Operations – The General Principles
Scott T. Fullwiler
Wartburg College; Bard College - The Levy Economics Institute
June 1, 2008
The debates between the structuralists and horizontalists highlighted the fact that endogenous money proponents had a very different understanding of monetary operations than did neoclassical economists. Indeed, as Fullwiler (2003) reports, until recently, research among neoclassicals related to bank behavior in the U. S. federal funds market had little relation to research on the Fed’s behavior, and vice versa, aside from a few notable exceptions. This has all changed considerably since the late 1990s, as neoclassical researchers found several issues that required bringing the two together – such as concerns about policy options at the zero bound, retail sweep accounts, payments system crises, and increased use of non-central bank wholesale settlement options. Whereas a detailed understanding of monetary operations has been central to research in the endogenous money tradition for decades now, it is not a stretch to suggest that it is now also a well-established area of research within neoclassical monetary economics.
There are sharp differences between the two approaches that nonetheless remain. Among neoclassicals, the literature on central bank operations is not integrated into models of financial asset pricing or into the so-called “new consensus” model of the economy. Though the latter assumes interest-rate targeting, new consensus models are concerned with the strategy of monetary policy, not the tactics or daily operations; though well-established as a research topic for journal publications, monetary policy implementation remains “a side issue” in neoclassical monetary theory graduate textbooks like Walsh (2003) (Bindseil 2004, 1). Further, neoclassicals still do not consider money to be endogenously created in the banking system, as Marc Lavoie repeatedly notes; indeed, as Charles Goodhart has argued in a series of recent papers, there is in fact no private banking system whatsoever in the new consensus model (e.g., Goodhart 2008a).
This is disappointing, naturally, since the evidence published in the recent neoclassical literature on central bank operations has in fact been remarkably consistent with the endogenous money view of central bank operations. The horizontalist view that central banks only target interest rates directly (not reserve or monetary aggregates) and can do so as precisely as desired has been in particular repeatedly supported by this literature. While the relevant literature could fill several volumes, of special note here is the book by Ulrich Bindseil (2004), former Head of the ECB’s Liquidity Management Section, which describes in substantial detail the operations of the Fed, ECB, and Bank of England in a manner that very nearly resembles the horizontalist story.
The purpose of this chapter is to describe ten general principles of modern central bank operations. These ten principles are not intended to be exhaustive or comprehensive; neither are the discussions of the individual principles necessarily exhaustive. Rather, these principles represent “what every economist should now be expected to know” given the large quantities of orthodox and heterodox research in this area and the empirical or anecdotal evidence contained in speeches and publications of central bank officials. As noted already, this research generally confirms the earlier points made by Moore (1988) and other authors associated in one way or another with the horizontalist literature
Number of Pages in PDF File: 47
Keywords: central bank operations, endogenous money, liquidity effect, interest rate targeting, payment settlement
JEL Classification: E40, E51, E52
Date posted: August 14, 2010