New Wine in Old Bottles: Unintended Financial Dominance and Central Banking Myopia

33 Pages Posted: 14 Dec 2024

See all articles by Donato Masciandaro

Donato Masciandaro

Bocconi University - Department of Economics; Bocconi University - Department of Economics (ECO)

Davide Romelli

Trinity College (Dublin) - Department of Economics; Trinity College (Dublin)

Riccardo Russo

Bocconi University - Department of Economics

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Date Written: December 12, 2024

Abstract

Using a political economy approach, this article offers a positive analysis of the relationships between macroeconomic fundamentals, unintended financial dominance, and central banking myopia. If the present level of public and/or private leverage depends on past monetary and/or supervisory policies, it follows that the risks of financial dominance can be associated with past policy decisions, where expectations represent the intertemporal transmission mechanism. Expectations can incorporate the likelihood of financial dominance through two factors-a de jure capture bias and a de facto accommodation bias-which are independent from the preferences of the central banker in charge. In this case, central banking myopia becomes endogenous, and financial dominance is unintended. This theoretical framework is used to interpret the wave of reforms in central bank design adopted in the aftermath of the Great financial crisis as the result of a stronger capture bias, and the adoption of unconventional monetary policies as the result of a stronger accommodation bias.

Keywords: financial dominance, central banking, monetary policy, supervision, central bank independence, political economy, principal agent setting, Great financial crisis, unconventional monetary policies

JEL Classification: D02, E31, E32, E42, E51, E58, E61, G28, H11, N20, P16

Suggested Citation

Masciandaro, Donato and Romelli, Davide and Russo, Riccardo, New Wine in Old Bottles: Unintended Financial Dominance and Central Banking Myopia (December 12, 2024). BAFFI Centre Research Paper No. 236, Available at SSRN: https://ssrn.com/abstract=5053363 or http://dx.doi.org/10.2139/ssrn.5053363

Donato Masciandaro (Contact Author)

Bocconi University - Department of Economics ( email )

Via Gobbi 5
Milan, 20136
Italy

Bocconi University - Department of Economics (ECO) ( email )

Via Gobbi 5
Milan, 20136
Italy

Davide Romelli

Trinity College (Dublin) - Department of Economics ( email )

Arts Building
Room 3014
Dublin
Ireland

Trinity College (Dublin) ( email )

2-3 College Green
Dublin, Leinster D2
Ireland

Riccardo Russo

Bocconi University - Department of Economics ( email )

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