Central Banking: Theory and Practice in Sustaining Monetary and Financial Stability

The book discusses how central banks monitor and identify risks to financial stability in the macro-economy, financial intermediaries, and financial markets using various tools and indicators.   The tools used for maintenance of financial stability in each of the areas will also be reviewed: (a) the use of monetary policy and macro-prudential measures to maintain stability in the macro-economy; (b) the use of capital requirements (Basel I, II, and III), as well as micro and macro-prudential measures, and liquidity provision to maintain stability of financial intermediaries; (c) the use of monetary policy and liquidity provision to maintain stability in financial markets. The book reviews the theoretical foundations (e.g. the quantity theory of money, natural rate of unemployment (NAIRU), rational expectations hypothesis, and time-inconsistency problem) and historical experiences (e.g. the great inflation of the 1970s) that support such mandates. It looks at actual practices whereby central banks can achieve such mandates (through an inflation target or an exchange rate target) and why such targets might be chosen, as well as reviews exchange rate theories and how the central banks influence the exchange rates.