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The Future of Central Banking in the Changing Financial Environment

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    During the last decades there were deep technology-driven changes in financial systems of many countries. The result was the decreasing demand for cash and commercial banks’ liquid reserves. The decreasing demand for central bank money has changed the operational side of the monetary policy. The maturities of open market operations have been shortened substantially. The reserve requirements were lowered or eliminated. The changes lead to a decrease in the volume of the monetary base, but the demand for central bank money will not vanish. Even with zero reserve ratio commercial banks will keep cash balances with central banks to settle their transactions. Thus, there will be a demand for banks’ liquid reserves and cash. Despite the decreasing demand for the monetary base, the central banks ability to influence the level of short-term interest rates will not be impaired, because central banks will continue to play the role of clearing houses for the banking systems. The central bank ability to conduct monetary policy does not depend on the volume of the monetary base, but on the demand for interbank settlements made by central bank. This is not the size of the monetary base either, that decides about the effectiveness of the monetary policy. Monetary authorities can influence interest rates via the payment system, which is typically based in central bank. The consequence of the decrease in the monetary base will be a fall in seigniorage income, but this will not impair central banks ability to conduct monetary policy. Interbank settlements must be located in central banks due to their reliability and the ability to play the role of lenders of last resort. As the central banks will stay as the institutions refinancing the payment system, they will decide about the level of short-term interest rates. Electronic money will not change the situation, because if this kind of money is to be widely accepted, it has to be exchanged into central bank money.

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    Paper provided by Narodowy Bank Polski, Economic Research Department in its series NBP Working Papers with number 33.

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    Length: 29
    Date of creation: 2005
    Handle: RePEc:nbp:nbpmis:33
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    1. Antoine Martin, 2002. "Reconciling Bagehot with the Fed's response to Sept. 11," Research Working Paper RWP 02-10, Federal Reserve Bank of Kansas City.
    2. Michael Woodford, 2001. "Monetary policy in the information economy," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 297-370.
    3. John Hawkins, 2001. "Electronic finance and monetary policy," BIS Papers chapters,in: Bank for International Settlements (ed.), Electronic finance: a new perspective and challenges, volume 7, pages 98-105 Bank for International Settlements.
    4. Bank for International Settlements, 2001. "Electronic finance: a new perspective and challenges," BIS Papers, Bank for International Settlements, number 07.
    5. McCallum, Bennett T, 2000. "The Present and Future of Monetary Policy Rules," International Finance, Wiley Blackwell, vol. 3(2), pages 273-286, July.
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