New Wine in Old Bottles Unintended Financial Dominance and Central Banking Myopia
34 Pages Posted: 14 Jan 2025
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New Wine in Old Bottles: Unintended Financial Dominance and Central Banking Myopia
New Wine in Old Bottles Unintended Financial Dominance and Central Banking Myopia
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: D02, E31, E32, E42, E51, E58
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