In Search for a New Monetary Policy Framework

Ioanna Kokores

Chapter Chapter 4 in Monetary Policy in Interdependent Economies, 2023, pp 73-95 from Springer

Abstract: Abstract This chapter argues on a major rethinking of the basic framework for monetary policy following the recognition that the financial sector plays an important role in the macroeconomy and that it can be highly nonlinear at times. A stronger case currently holds for central banks considering a risk management framework. As commercial banking system has ceased to be reserve-constrained, monetary authority actions to change the size of the central bank balance sheet do not affect the nation’s money supply. One thing central banks can control is the size of their balance sheets, but unlike other portfolio managers, they acquire additional financial assets by creating liabilities (by creating money) and not by selling other assets. This transformation is vital in modern financial markets, which use “riskless” government debt as collateral for many types of transactions. Commercial bank deposit liabilities are now a function of the supply of earning assets—both domestic and foreign—offered to commercial banks. Ballooning central bank balance sheets may fuel extreme rates of inflation without further debt monetization. The institutional relationship between the central bank and the Treasury remains crucial in determining the success of balance sheet policies, also not undermining the central bank’s independence.

Date: 2023
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Persistent link: https://EconPapers.repec.org/RePEc:spr:fimchp:978-3-031-41958-4_4

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DOI: 10.1007/978-3-031-41958-4_4

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