Bill Nelson on the Future of Central Bank Operating Systems

This episode explores the shift among advanced economy central banks from supply-driven to demand-driven monetary policy operating systems. Against the backdrop of massively expanded balance sheets following the global financial crisis and the COVID-19 pandemic, the discussion centers on central banks' efforts to reduce reserve balances. More significantly, the conversation highlights the transition to a "demand-driven ceiling system," where banks borrow from the central bank to meet their reserve needs, rather than relying on the central bank's supply of reserves. For instance, the Bank of England's experience with its new policy implementation framework is examined, revealing a trilemma involving interest rate control, cheap central bank liquidity, and interbank market activity. The potential for political pressure to influence the use of central bank balance sheets is also discussed, with the Fed's current situation and potential future adjustments being a focal point. Ultimately, the episode emphasizes the need for a more robust interbank market and the importance of considering the costs associated with maintaining large central bank balance sheets, suggesting that a smaller, more market-driven approach may be more efficient and sustainable in the long run.