Central Banking and Financial StabilityDecima Lezione Paolo Baffi

The modern literature on monetary policy emphasizes the central bank’s role in fostering price stability. Historically, however, a dominant concern for central bankers has been not just price stability, but also financial stability.

Indeed, Goodhart (1988) argues that the original motivation for creating central banks in many countries was to temper the financial crises associated with unregulated “free banking” regimes:

“In the nineteenth century, the advocates of free banking argued that the banking system could be trusted to operate effectively without external constraints or regulation….[But] experience suggested that competitive pressures in a milieu of limited information (and, thence, contagion risks) would lead to procyclical fluctuations punctuated by banking panics. It was this experience that led to the formation of noncompetitive, non-profit maximizing Central Banks.” [...]

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