Banking on the Future

The Mighty Have Fallen

Blame for the financial crisis that began in 2007 landed easily and plentifully at the feet of the world’s central banks. Few had drawn attention to the build-up in asset prices – particularly housing prices – and to the inherent flaws of derivatives, instruments intended to mitigate risk that instead amplified and spread contagion throughout the financial system. When sparks flew in the summer of 2007, central banks had little in the way of firefighting equipment to douse the monetary flames. Central bankers were caught flat-footed with interest rates close to zero, bank reserves insufficient and a “shadow banking” system out of their control. Yet how could the world’s monetary authorities have missed the signals of an impending crash? How was their “radar...not connected to the missile defenses?” Did their focus on inflation management and monetary stability blind them to the changing economic picture? Should they have focused on asset prices along with interest rates? Were they out of touch with rapidly advancing financial innovation? Were they ill-prepared to collaborate in a crisis, not only among their cross-border confreres but with their own...