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Financial Deregulation, Monetary Policy, And Central Banking

  • GOODFRIEND, M.
  • KING, R.G.

The paper analyzes the need for financial regulations in the implementation of central bank policy. It emphasizes that a central bank serves two functions. Central banks function as monetary authorities, managing high-powered money to influence the price level and real activity; and they engage in regular and emergency lending to financial institutions. The authors term these functions monetary and banking policies, respectively. They emphasize that regulations are not essential for the execution of monetary policy because high-powered money can be managed with open market operations in government bonds. By its very nature, however, banking policy involves a swap of government securities for claims on individual banks. Just as private lenders must restrict and monitor individual borrowers, a central bank must regulate and supervise the institutions that borrow from it. Virtually all economists agree that there is an important role for monetary policy to stabilize prices and real activity. Banking policy has been rationalized as a source of funds for temporarily illiquid but solvent banks. To assess that rationale, the authors develop the distinction between illiquidity and insolvency in detail, showing the distinction to be meaningful precisely because information about the value of bank assets is incomplete and costly to obtain. Nevertheless, they explain why the cost of information per se cannot rationalize banking policy. On the basis of such considerations, they find it difficult to make a case for banking policy and the regulatory and supervisory activities that support it.

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Paper provided by University of Rochester - Center for Economic Research (RCER) in its series RCER Working Papers with number 121.

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Length: 30 pages
Date of creation: 1988
Date of revision:
Handle: RePEc:roc:rocher:121
Contact details of provider: Postal: University of Rochester, Center for Economic Research, Department of Economics, Harkness 231 Rochester, New York 14627 U.S.A.

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  4. Timberlake, Richard H, Jr, 1984. "The Central Banking Role of Clearinghouse Associations," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 16(1), pages 1-15, February.
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  20. Gorton, Gary B. & Haubrich, Joseph G., 1987. "Bank deregulation, credit markets, and the control of capital," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 26(1), pages 289-333, January.
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  30. Cukierman, Alex & Meltzer, Allan H, 1986. "A Theory of Ambiguity, Credibility, and Inflation under Discretion and Asymmetric Information," Econometrica, Econometric Society, vol. 54(5), pages 1099-1128, September.
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