How to Stabilize the Banking System: Lessons from the London Money Market
December 17, 2015
This paper argues that the British financial system in the era prior to World War I provides modern policymakers with a successful model of how to stabilize the banking system. This model had two components: incentives were structured to ensure that all banks that originated or traded assets on the money market sought only to trade in high-quality assets, and macro-prudential regulation promoted the segregation of money markets from capital markets, monitored the growth of money market credit, and restricted trade on the money market in assets issued by entities and sectors whose money market liabilities were growing so fast that the most reasonable explanation was that the money market was being used to finance longer-term investment. These facts indicate that policymakers can successfully stabilize the banking system through a combination of structural reform and regulation of the growth of credit.
Number of Pages in PDF File: 27
Keywords: prime bank bills, commercial bills, real bills, safe assets, macro-prudential regulation, financial stability, discount policy, London money market, central banking, Bank of England
JEL Classification: E58, N23
Date posted: May 31, 2016