Financial Instability and the Decline (?) of Banking: Public Policy Implications

Abstract

Banking plays two roles in a modern capitalist economy: It provides a means of payment and channels resources into capital development. These functions are being performed to a decreasing extent by banks, and it appears that this trend will continue. Such developments suggest that the economic role of central banks needs to be reviewed because the role of banks is significant in the ability of the central bank to conduct monetary policy. This ability is changing due the transformation of the channels through which Federal Reserve operations affect the economy away from affecting the availability or cost of financing and toward affecting uncertainty, the evaluation by portfolio managers of the viability of enterprises, and the stability of markets. When central bank operations affect the uncertainty of financial market agents, market reactions will often be out of proportion to the size of the operation.