Issues in

Evolution of Central Banking Yale College Lucky Yona, Jr.

Contemporary
Central Banking
By Lucky Yona

Introduction
Over the years, central banking has evolved drastically and exhibited various

permutations. The discipline has been kept dynamic by new economic theories, changing

economic trends and relationships, and importantly, the occurrence of an assortment of

financial crises. Over the last few decades however, there has been an international

consensus on a definitive practice of central banking and monetary policy, namely,

inflation targeting. With maturing financial markets and price discovery mechanisms

worldwide, this modern light touch approach to central banking has been increasingly

considered the ideal. While achieving some macroeconomic objectives, this paper argues

that inflation targeting regimes do not sufficiently concern themselves with the wider

financial climate. Consequently, monsters can feed and grow in unattended to financial

markets, monsters that could render years of light touch measures mere busywork in a

matter of days. We see evidence for this most saliently in the financial crisis of 2008 and

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Evolution of Central Banking Yale College Lucky Yona, Jr.

the Asian financial crisis a few years prior where despite sensible inflation conditions

under targeting regimes, outcomes were nonetheless tragic. In both cases, financial

stability and regulation were not the mandate of central banking entities, entities that are

otherwise committed to ensuring the stability of their constituent economies. Add to this

a growing body of research and literature that questions the effectiveness of inflation

targeting in the first place, and the imperative to take a second look the current approach

to central banking regime becomes even more critical.

This paper will begin by briefly discussing the history of post Bretton Woods central

banking regimes, our arrival at the inflation targeting, and the apparent success of the

regime. The discussion will then segue into a survey of the arguments presented against

the effectiveness of inflation targeting regimes. Next, this paper will draw from the events

of the North Atlantic crisis to demonstrate the consequences of framework myopia and

argue in favor of a financial stability mandate among central banks worldwide. Policy

implications in public discourse will be outlined and supplemented with a few

observations. I will conclude with a brief discussion of challenges that central bankers

must wrestle in years to come pertaining to the emergence of drastically novel economic

and financial dynamics.

Central Banking and Monetary Policy after Bretton Woods

On the 15th of August, 1971, President Nixon stood up in front of the nation to

announce the suspension of US dollar convertibility to gold. This effectively put an end to

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Evolution of Central Banking Yale College Lucky Yona, Jr.

decades of the Bretton Woods monetary order. Monetary policy in the years to follow was

conducted ad hoc and without a particular framework.1 Immediately after, direct control

policies such as wage and price controls were implemented to manage economic

conditions but these proved unsustainable.2 Following this, the US and other major

economies went on to deploy tools such as interest rate policies (without a targeting

peremptory) and quantitive credit controlswhich placed direct restrictions on the

aggregate stock of credit in the wider financial systemin order to achieve monetary

policy objectives.3 A number of other economies chose to establish hard and soft pegged

exchange rates as their monetary system, placing exchange rate stability as the primal

focus of central banking, with other domestic interests taking a back seat.4 However, with

increases in capital flows over the years, along with other kinds of perturbation, this

system resulted in undue pressure on other important economic parameters and made

intervention difficult. Consequently, many economies did not stay on fixed regimes

(although some still do) for long and soon floated their currencies.5

1Ghizoni, S. (2017). Nixon Ends Convertibility of US Dollars to Gold and Announces Wage/Price Controls | Federal Reserve
History. [online] Federalreservehistory.org. Available at: https://www.federalreservehistory.org/essays/
gold_convertibility_ends
2 Ibid
3Brookings Institute. (2017). An Analysis of Credit Controls and related Devices. [online] Available at: https://
www.brookings.edu/wp-content/uploads/1971/01/1971a_bpea_davis_duesenberry_fand_krause.pdf
4 IMF (1996). Exchange Rate Regimes as Inflation Anchors. [online] Available at: https://www.imf.org/external/pubs/ft/
fandd/1996/03/pdf/quirk.pd
5Leduc, S. (2001). On Exchange Rate Regimes, Exchange Rate Fluctuations, and Fundamentals. SSRN Electronic
Journal

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Evolution of Central Banking Yale College Lucky Yona, Jr.

Other monetary systems were to follow. Benjamin Friedman of Harvard details one of

these such systems that was in place in the United States and other major economies

during the 1970s onwards: the use of explicit money growth targets. Under money

growth targeting, policymakers would decide upon an ideal rate of money growth (the

money base measure deployed varied across various jurisdictions) that was in line with

expectations of economic activity, price levels, employment and any other objectives of

the central bank in question. This was then contrasted with what was observed in the

economy. Should the observed money growth exceed the ideal, then instruments such as

short term interest rates were deployed in order to bring the monetary aggregates in line

with the policymakers expectations.6 But money growth targeting was soon to face its

own demise. Financial innovation in the late 1970s, manifesting notably as the rise of

money market mutual funds meant that traditional regulated deposits were increasingly

not representative of actual monetary conditions. In response to this, intermediate steps

were taken, such as a switch to a broader money target in the United States, and later a

move from money quantity targets to price of money of money targets.7 However,

continued financial innovation and the abstraction of financial activity into dimensions

not captured by traditional monetary aggregates meant that money growth targeting as a

major monetary policy regime was doomed. In the early nineties, Alan Greenspan,

Chairman of the Federal Reserve at the time, was quoted by the New York times that

6 Friedman, B. (1996). The Rise and Fall of Money Growth Targets as Guidelines for U.S. Monetary Policy.
7 Ibid

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Evolution of Central Banking Yale College Lucky Yona, Jr.

the relationship has completely broken down8, marking the United States transition

away from the two decade long era of money growth targeting.

Following the dismissal of money growth targeting by the Fed in the summer of 1993, a

new era in central banking was soon to be birthed and an international consensus began

to emerge. A significant number of advanced and emerging economies alike began to

adopt a number of central banking ideals. To begin with, central banking independence

and inviolability became a core tenant of any self respecting nation.9 Prior, central banks

worldwide were subservient to fiscal actions and imperatives that seriously jeopardized

stability imperatives. Many nations, advanced or otherwise, had interest rates that were

set by the respective Treasury; the Bank of England, for instance, only took full control of

interests rates in 1997. Stanley Fischer, Vice Chairman of the Federal Reserve, elegantly

summarizes the issue with fiscal interference in monetary policy by stating that the

theoretical case for monetary policy independence focused on countering inflationary

biases that were likely to exert themselves in the absence of an independent central

bank. 10 These biases, he continued, often arose from the political sphere, where there

may be strong pressure to temporarily boost activity for the sake of political clout, or

pressure to exploit central bank power to finance government expenditure. There seems

to be empirical support for this perspective; an extensive survey of the interplay between

8Steven Greenhouse (1993). Fed Abandons Policy Tied to Money Supply. [online] New York Times. Available at: http://
www.nytimes.com/1993/07/23/business/fed-abandons-policy-tied-to-money-supply.html [Accessed 8 Dec. 2017].
9 Goodman, J. (1991). The Politics of Central Bank Independence. Comparative Politics, 23(3), p.329.
10Board of Governors of the Federal Reserve System. (2017). Speech by Vice Chairman Fischer on central bank independence.
[online] Available at: https://www.federalreserve.gov/newsevents/speech/fischer20151104a.htm

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Evolution of Central Banking Yale College Lucky Yona, Jr.

central banking independence and economic performance reveals a positive relation

between the two.11

Along with central bank independence came a distinct focus on inflation management as

the primary goal for monetary policy. Economies worldwide started moving to inflation

targeting. The modern inflation targeting regime has a number of key features and

characteristics. 12 First, there must be an institutional commitment to the pursuit of price

stability as the utmost goal of monetary policy. Secondly, inflation targeting mandates for

the public announcement of specific numerical short to medium term targets for

inflation. Furthermore, there is a distinct orientation towards transparency in monetary

policy decisions and processes. Open communications with the public along with a set of

accountability measures for the central bank in attaining its inflation goals are generally

expected.13 But has the regime been a runaway success?

The Current Regime

There is a generally accepted understanding that inflation targeting is causally responsible

for the attainment of stable price levels in countries that adopted the regime. Indeed, the

era coinciding with the worldwide adoption of inflation targeting regimes is one

11Cukierman, A. (2008). Central bank independence and monetary policymaking institutions Past, present and
future. European Jouranl of Policitcal Economy.
12
Imf.org. (2017). Classification of Exchange Rate Arrangements and Monetary Frameworks. [online] Available at: http://
www.imf.org/external/NP/mfd/er/index.aspx
13Horvth, R. and Vako, D. (2016). Central bank transparency and financial stability. Journal of Financial Stability,
22, pp.45-56.

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Evolution of Central Banking Yale College Lucky Yona, Jr.

characterized by rather decreasingly low inflation across in the US and in economies

worldwide. The chart below demonstrates this trend in the United States.14 There is too, a

body of evidence to support a causal

link between this trend in inflation

and the adoption of inflation

targeting. Mishkin and Posen of the

Federal Reserve Bank of New York

demonstrated this in their paper on

Figure 1 Source: Statista, BLS

the outcomes of inflation targeting in New Zealand, Canada, and the United Kingdom.15

Comparing VAR projections of inflation based on historical data against realized inflation

under inflation targeting regimes, the authors demonstrate that inflation targeting was

effective in achieving price stability, and higher growth than on the previous trajectory.

The effect is illustrated on the chart below.

Source: (Mishkin & Possen, 1998) Figure 2: UK Projection vs. Realized Inflation under IT

14 https://www.statista.com/statistics/191077/inflation-rate-in-the-usa-since-1990/
15 Mishkin, F. and Posen, A. (1998). Inflation Targeting: Lessons from Four Countries.

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Evolution of Central Banking Yale College Lucky Yona, Jr.

Other researchers have also corroborated the positive outcomes of inflation targeting on

other economic metrics such as GDP growth.16 Mishkin doubled back on his analysis with

another paper ten years later that presented further empirical evidence that inflation

targeting helps countries achieve lower inflation in the long run, have smaller inflation

response to oil-price and exchange-rate shocks, strengthen monetary policy

independence, improve monetary policy efficiency, and obtain inflation outcomes closer

to target levels. This assertions are widely supported in the community.17,18 Have we

hence arrived at the final state of central banking?

The Current Regime Reassessed

In stark contrast to the evidence in favor of the effectiveness of inflation targeting regimes

presented above, the first questioning to the central banking status quo to be discussed

here, has to do with a growing body of evidence that seems to undermine the premise

that inflation targeting is an effective monetary policy and central banking framework. For

instance, after conducting an intervention analysis on time series data, researchers out of

Cambridge demonstrated that central banks which adopted inflation targeting did not

experience inflation reduction beyond that which would have occurred regardless of the

intervention. They further argued that the countries originally studied by proponents

16 Amira, B., Mouldi, D. and Feridun, M. (2013). Growth effects of inflation targeting revisited: empirical evidence
from emerging markets. Applied Economics Letters, 20(6), pp.587-591.
17
Bernanke, B.S. A Perspective on Inflation Targeting. Remarks delivered at the Annual Washington Policy
Conference of the National Association of Business Economists, Washington, DC, March 25, 2003.
18Corbo, V.; Landerretche, M.O.; and Schmidt-Hebbel, K. Assessing Inflation Targeting After a Decade of World
Experience. Central Bank of Chile, Santiago, 2001.

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Evolution of Central Banking Yale College Lucky Yona, Jr.

(Mishkin in particular) of inflation targeting were already experiencing a downward trend

in inflation.19 Another group of researchers found that there is no discernible effect

directly attributable to inflation targeting in advanced economies, while developing

countries actually suffer from the adoption of an inflation targeting regime.20 While I

have picked only two studies here for demonstrations purposes, these publications are

accompanied by many other apprehensive reassessments of the inflation targeting

regime.21,22 The evidence presented here does not mean we should immediately throw

inflation targeting out of the window. Rather, as phrased by Mohan, it reveals an ongoing

questioning of existing intellectual assumptions with respect to the functioning of

markets.23 Additionally, the awareness that inflation targeting may not be as foolproof

should embolden central bankers and policymakers to consider unconventional ideas that

fall out of consensus but my otherwise have potential. Indeed, there is some evidence to

suggest that strict inflation stabilization objectives under may be more costly than liberal

(or experimental) policies.24 Indeed, Ben Bernanke infamously proclaimed that monetary

19Angeriz, A. and Arestis, P. (2006). Has inflation targeting had any impact on inflation?. Journal of Post Keynesian
Economics, 28(4), pp.559-571.
20Anna Samarina, Mirre Terpstra & Jakob De Haan (2014). Inflation targeting and inflation performance: a
comparative analysis. Applied Economics Vol. 46 , Iss. 1,2014
21Willard, Luke Byrne. Does inflation targeting matter? A reassessment. Applied Economics, vol. 44, no. 17, 2012,
pp. 22312244., doi:10.1080/00036846.2011.564136.
22Huang, Ho-Chuan, and Chih-Chuan Yeh. Inflation targeting on unemployment rates: a quantile treatment effect
approach. Applied Economics Letters, vol. 21, no. 7, 2014, pp. 453458., doi:10.1080/13504851.2013.866198.
23 Mohan, R. (2011). Growth with Financial Stability. Delhi: Oxford University Press.
24Tillmann, Peter. The conservative central banker revisited: Too conservative is more costly than too liberal.
European Journal of Political Economy, vol. 24, no. 4, 2008, pp. 737741., doi:10.1016/j.ejpoleco.2008.09.006.

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Evolution of Central Banking Yale College Lucky Yona, Jr.

policy is too blunt a tool to be routinely used to address possible financial imbalances.25

The policy implications for this are discussed in a latter section.

The second pain in the neck with the current central banking regime is the rather myopic

operational scope. As mentioned earlier while discussing the prime features of the

inflation targeting regime, inflation is a core, and rather dominant tenant of modern

central bank policy scope. In the years leading up to the North Atlantic financial crises,

inflation was at rather low levels and the Fed, singularly focussed, continued to maintain

detrimental accommodative monetary policy. This all happened in the backdrop of

mushrooming credit, derivatives, and shadow banking activity, among other ills in the

economy. Similarly, in the years leading up to the dot-com crises of the early 2000s,

monetary policy would have seemed rather successful as inflation was low and CPI

numbers were tame.26 Yet in both of these crises, outcomes that matter to a central bank

and the citizens in its jurisdiction were affected rather severely, with deflationary pressure

and tragic losses in output and employment as some of the dire consequences of the

crises. It is clear in observation of these crises that the scope of the central banks

mandate is perhaps to be reconsidered. Ultimately, the goal of inflation targeting is, for all

practical purposes, financial stability. But before we can discuss policy and scope

25Speech by Chairman Bernanke on the effects of the great recession on central bank doctrine and practice. (n.d.).
Retrieved December 10, 2017, from https://www.federalreserve.gov/newsevents/speech/bernanke20111018a.htm
26CPI-All Urban Consumers (Current Series) . U.S. Bureau of Labor Statistics, U.S. Bureau of Labor Statistics,
data.bls.gov/pdq/SurveyOutputServlet.

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Evolution of Central Banking Yale College Lucky Yona, Jr.

implications, we must first observe, from the legacy of crises past, what forces are the

major culprits in precipitating systemic instability.

Lessons from the North Atlantic Crisis

Despite a surface level diversity in the nature and causes of crises, a unifying theme

amongst almost all of them is a proliferation of excessive leverage. Indeed, even before

the North Atlantic crisis, there was some understanding of this issue; the Basel process

had been put in place to ensure healthy and sufficient capitalization in banks not too long

prior. However, in the case of the North Atlantic crisis, excessive confidence in the risk

management systems of Banks (under erroneous assumptions about efficient markets

incentivizing prudence) meant that some banks remained compliant with Basel guidelines

while holding trivial capital reserves.27 Along with this came the rapid growth in

securitized credit and complex derivatives. The magic of securitized products was that

they transformed illiquid underlying assets into liquid financial instruments of seemingly

high quality. The blunder among regulators on this matter was centered around efficient

market hypothesis doctrine, with the prevailing view being that such products would

attenuate and soak up shocks to the financial system.28 Add to this a fattening shadow

banking sector that allowed for reduced capitalization among traditional banks, further

growth in credit and securities derivatives, and bogus credit rating institutions, and the

consequence was that the global economy became bicameral. Finance, and real

27 Mohan, R. (2011). Growth with financial stability. Delhi: Oxford University Press.
28 Ibid

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economic activity were divorced; by 2005 trading in oil futures was 10 times the actual

volume of oil produced. 29 With financial regulators unable to properly assess risk in this

new complex financial system due to old tools, the global economy was destined for

doom. In the backdrop of the North Atlantic Crisis, what should be the new bounds of

central bank responsibility and how might this manifest in practice?

Financial Stability as a Central Banking Mandate

While central banks deploying inflation targeting certainly help reduce the probability

that toxic credit and asset bubbles emerge, the evidence explored in this paper suggests

that a more granular approach is necessary and it is argued here, in agreement with

growing support from field experts,30 that financial stability should be a principle tenant in

the practice of central banking. Some notable policy implications of this mandate are

explored in this section. Nonetheless, it is not expected that a central bank bring all the

regulation functions to be discussed under one house. Rather, it is proposed here that

some critical financial stability interventions be made internal, with the rest being closely

overseen by the central bank. A new revised mandate could perhaps stipulate the

following: (1) Maintain low and stable inflation (or some other macro objective), (2)

Undertake the oversight, coordination, and supervision of regulatory bodies for all

systemically important financial markets and their ancillaries. With this speculative

29 Ibid
30 Ibid

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Evolution of Central Banking Yale College Lucky Yona, Jr.

framework for the implementation of the financial stability mandate, we will commence

to explore the practical ramifications of such, beginning with the matter of asset prices.

Assuming that central banks worldwide continue to prefer inflation targeting, notable

improvements can still be made, ones that would encourage stability. As put forward by

Cecchetti, a central bank concerned with stabilizing inflation about a specific target level

is likely to achieve superior performance by adjusting its policy instruments not only in

response to its forecast of future inflation and the output gap, but also to asset prices. 31

Under this view, critical financial markets that often originate crises, are more closely

monitored for asset price misalignment, a task, the author suggests, that is not any more

difficult than estimating output, inflation and other theoretical metrics, while offering

more robust risk mitigation. This indeed offers an arguably quick easy fix to the current

regime with little structural reform. For this reason, it prioritized here as very pragmatic

and politically feasible reform guideline.

Macroprudential regulation, the second policy imperative, concerns itself with the

mitigation of systemic financial risk and clarifies policy implications. Mohan identifies a

number of areas of prudential oversight that require fortification such as capital adequacy

and infrastructure provision for OTC derivatives.32 Promisingly, the first of these has

already seen meaningful discussion and ongoing transformation. The ideal for capital

31Cecchetti, S. (2001). Asset prices and central bank policy. Geneve: Internat. Center for Monetary and Banking Studies
[u.a.].
32 Mohan, R. (2011). Growth with financial stability. Delhi: Oxford University Press.

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Evolution of Central Banking Yale College Lucky Yona, Jr.

adequacy following the crisis has been improved quality and quantity of capital among

financial institutions, especially with respect to Basel Tier I capital. Indeed, changes to the

Basel rules mean that by 2019, banks will have to abide to stricter capital requirements.33

Nonetheless, Tier I capital quality requirements, though stricter, still wont meet an ideal

were only common equity and retained earnings classify as Tier I. Basel requirements can

also be supplemented by dynamic and weighted capital and liquidity requirements.

Rather than set static requirements, a new regime of freely adjustable requirements could

allow for much better risk mitigation and provide powerful macro control for central

bankers throughout business cycles. Further, weighting such requirements depending on

an institution's size and importance also provides further safety, as systemically vital

entities can be held to higher standardw. Importantly, it is insisted upon here that if some

of the concessions made available to superior risk managing institutions as they were in

the previous crisis, we can expect problematic patterns to reemerge. It is crucial that

regulators assume that what can go wrong, certainly will and that no particular institution,

no matter its clout or pedigree, is immune or entitled to differential treatment.

With observers taking lessons form the crisis of 2008, there has been increased favor for

improved infrastructure and regulation in the over the counter (OTC) derivatives market.

To ensure a similar level of accountability to highly traded financial instruments, central

banks should demand that OTC derivates such as credit default swaps (CDS) be traded

on central exchanges rather than bilaterally, and be subject to transparency and reporting

33 Ibid

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Evolution of Central Banking Yale College Lucky Yona, Jr.

obligations similar to those for traditional financial instruments such as equities. This too

seems like a promising avenue for the reduction of systemic risk. As regulators begin to

make this a reality however, they must be aware that the implementation of such central

exchanges, despite benefits, may also present some risks. I argue here that such systems,

will make complex derivatives highly liquid, and create an environment for the creation

of third and fourth order derivatives that if not sufficiently regulated, may worsen

regulators woes.

Yet another weakness in macro-prudence that was made apparent by the recent financial

crisis was the lack of any meaningful regulation of large private capital pools. Private

equity and hedge funds, sectors that are now at economy threatening size cannot go be

free to do as they please. Applying similar capital requirements, and risk management

measures deployed in regular financial institutions will be crucial. Otherwise, the

phenomenon of regulatory arbitrage would undermine efforts as capital flows to less

restricted34 sectors in search of yield. It is this same phenomenon that can be attributed to

the growth of the shadow banking sector in the United States.

A crucial part of macroprudential regulation is possessing metrics that provide

practitioners with a true pulse of underlying conditions. Mohan proposes that better

designed systemic risk metrics would include capital adequacy ratios with systemic risk

factors. Such risk factors to be internalized in such a metric include leverage ratios,

34 Ibid

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Evolution of Central Banking Yale College Lucky Yona, Jr.

maturity mismatch and bank credit expansion.35 I add here that in the current

environment, it would be rather trivial (in technological terms) for regulators to mandate

automatic, real time live reporting of these metrics and others, directly from systemically

significant financial institutions; these institutions already use these metrics themselves in

their computer systems to monitor performance and for other purposes. While politically

difficult, strengthened central bank independence and authority could allow for such

implementations and the result would be holistic and timely measures of systemic risk in

hyper dynamic financial markets, allowing regulators to curb problems more competently.

Financial Stability in Uncharted Territory

While the risks and consequences of financial under-regulation have been exposed earlier,

I feel strongly that a discussion of issues in contemporaneous central banking would not

be complete without examining a few notable developments. As a consequence of these

developments, monetary policy and financial regulation will become exceedingly difficult

to execute effectively, and the risks to failure much more consequential.

Since the early 2000s, new types of market participants have been at play, ones that

violate traditional assumptions of market actor behavior. Take for example a type of

algorithmic trading known as high frequency trading (HFT). Under HFT, computer

algorithms decide on portfolio positions and these positions are held for seconds or

35 Ibid

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Evolution of Central Banking Yale College Lucky Yona, Jr.

fractions of a second before exit. The fastest high frequency trading robots can execute as

many as 40,000 trades in the time it takes to blink an eye.36 As of 2016, it is estimated that

between 10-40% of all US equities trading volume was attributable to HFT,37 while 60%

of futures trades in 2012 were also initiated by HFT.38 While there is evidence to support

that HFT increases the degree of liquidity in the market due to the effective price

discovery mechanisms of the hyper fast computerized systems,39 the dangers of such

financial activity have already reared a head. On May 6, 2010 at 2:32 PM Eastern Time,

a large e-mini (a tradable index future contract) sale was initiated by a mutual funds

(Waddell & Reed Financial) trading algorithm. HFT robots reacted dramatically. They

quickly dumped e-minis while cross-market arbitrageurs robots did the same in equities

markets. Running out of demand for e-minis, the HFTs started rapidly trading amongst

themselves, forcing prices lower.40 The end result? $1 trillion in market value disappeared

across various exchanges only to recover about 40 minutes later in what was coined the

Flash Crash. Speaking on what he called a near miss, Andrew Haldane, Chief

Economist at Bank of England, lamented:

[The flash crash] taught us something important, if uncomfortable, about our state

of knowledge of modern financial markets. Not just that it was imperfect, but that

36 Bis.org. (2017). The Race to Zero. [online] Available at: https://www.bis.org/review/r110720a.pdf

37Aldridge, I., Krawciw, S., 2017. Real-Time Risk: What Investors Should Know About Fintech, High-Frequency
Trading and Flash Crashes. Hoboken
38 Polansek, Tom (23 August 2013). "CFTC finalizes plan to boost oversight of fast traders: official". Reuters.
39Brogaard, Jonathan, et al. High-Frequency Trading and Price Discovery. Review of Financial Studies, vol. 27, no. 8,
2014, pp. 22672306., doi:10.1093/rfs/hhu032.

"40 U.S. Securities and Exchange Commission and the Commodity Futures Trading Commission (September 30,
2010). "Findings Regarding the Market Events of May 6, 2010" (PDF)

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Evolution of Central Banking Yale College Lucky Yona, Jr.

these imperfections may magnify, sending systemic shockwaves... Flash crashes, like

car crashes, may be more severe the greater the velocity.

While the Flash Crash of 2010 resolved rather easily and without intervention, the

outcomes had the potential to be much worse if, for example, a group of highly

capitalized HFTs were programmed to execute hedging trades in other securities and

exchanges, and consequently triggered more cascades of sell offs. Even so, HFT trading is

only one example of unfamiliar yet substantive novel financial phenomenon. The

meteoric rise of bitcoin (among other non-sovereign cryptocurrencies) to about $300

billion41 in market capitalization this year marks the beginning of a challenging era for

central bankers with puzzles such as ungovernable cross-country currency flows,

extremely high volatility, evidence of flash crash like currency market events,42 and an

unclear path to monetary policy if at all possible. The key point here is that finance is

changing more dramatically than (arguably) ever before and such developments are not

isolated or niche, but are quickly becoming relevant tensors as pertaining to financial

stability. Fortunately, a conversation has already began among economic scholars,

regulates and beyond. For instance, out of Chicago came a brilliant proposal to redesign

exchanges to eliminate the HFT arms race. In such markets orders [are] processed in a

batch auction instead of serially reducing the potential for volatile high speed trades.43 It

41

42Reid, D. and Kharpal, A. (2017). Bitcoin suffers mystery flash crash on popular cryptocurrency index. [online] CNBC.
Available at: https://www.cnbc.com/2017/10/10/bitcoin-price-falls-after-russia-proposes-ban-on-exchanges.html
43Budish, E., Cramton, P. and Shim, J. (2015). The High-Frequency Trading Arms Race: Frequent Batch Auctions
as a Market Design Response. The Quarterly Journal of Economics, 130(4), pp.1547-1621.

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Evolution of Central Banking Yale College Lucky Yona, Jr.

is this level of engagement with current affairs that is necessary for regulators and central

bankers to keep up with modern financial markets.

Conclusion

This paper is titled Issues in Contemporary Central Banking and as such, I have tried to first,

establish context by exploring the recent history of central banking and transition to the

current dominant regime, along with a discussion of the increasing doubts about its

effectiveness as revealed by literature and crisis. Nonetheless, it was not my intent to

dismiss inflation targeting entirely but rather start a conversation on the path to better

financial governance. Drawing from literature, practical discussed implications were

discussed, and actionable policy imperatives, such as . Importantly, I have tried to provide

a taste, in a very simplified manner, of how advanced technologies

While fully embracing the mandate of financial stability and the policy imperatives within

that mandate would be there is a new rigor that will be required of central bankers

pursuing that goal. As a financial professional commenting on the Flash Crash remarked,

If central banks are to remain functional, they need to adapt faster to financial markets

than they do now. In their ranks, there must be as many computer scientists as there are

economists. This a mere matter of pragmatism. How can one decide on what regulation

measure to deploy to curb a particular threat to stability, let alone enforce it, if they do

not sufficiently grasp the concept

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