Introduction

Central banking will never be quite the same again after the global financial crisis. The crisis will no doubt prove to be one of those rare defining moments in the history of this institution—an institution that, from its faltering first steps in the seventeenth century, has grown to become widely regarded as indispensable.

At first glance, central banks have emerged as the great winners among policy institutions. They have been rightly hailed as saviors of the global financial system: their swift and internationally coordinated action, through liquidity support and interest rate cuts, prevented the system's implosion. And they have gained much broader powers: no one questions any longer their crucial role in financial stability, which is being hardwired into legislation, while some are regaining the regulatory and supervisory functions lost in previous decades.

And yet, beneath this glittering surface, the picture is less reassuring. The crisis has shaken the foundations of the deceptively comfortable central banking world. Pre-crisis, the quintessential task of central banks was seen as quite straightforward: keep inflation within a tight range through control of a short-term interest rate, and everything else will take care of itself. Everything was simple, tidy, and cozy. Post-crisis, many certainties have gone. Price stability has proven no guarantee against major financial and macroeconomic instability. Central banks have found themselves reaching well beyond interest rate policy, aggressively deploying their balance sheet in a variety of “unconventional” monetary policies. As a result, the line between monetary and fiscal policy has become blurred precisely at a time when public sector debts are ballooning and sovereign risk is rising again. And many increasingly question the very ability of central banks to maintain inflation within acceptable ranges, notably to avoid deflation. Nor is the boom underway in the price of gold precisely a vote of confidence in the international monetary system.

The years ahead will be a period of experimentation in central banking (Goodhart 2010). Central banks face a threefold challenge: economic, intellectual, and institutional. First, they will operate in a hostile economic environment.