It is likely that regulatory policy would need to be in a constant state of alert for risks emerging in the financial shadows, which could trip up regulators and the financial system. In other words, regulatory fine-tuning could become the rule, not the exception. In this world, macro-prudential policy to lean against the financial cycle could become more, not less, important over time. With more risk residing on non-bank balance sheets that are marked-to-market, it is possible that cycles in financial assets would be amplified, not dampened, relative to the old world. Their transmission to the wider economy may also be more potent and frequent. The demands on macro-prudential policy, to stabilise these financial fluctuations and hence the macro-economy, could thereby grow. In this world, central banks’ operational policies would be likely to remain expansive. Nonbank counterparties would grow in importance, not shrink. So too, potentially, would more exotic forms of collateral taken in central banks’ operations. Market-making, in a wider class of financial instruments, could become a more standard part of the central bank toolkit, to mitigate the effects of temporary market illiquidity droughts in the non-bank sector. In this world, central banks’ words and actions would be unlikely to diminish in importance. Their role in shaping the fortunes of financial markets and financial firms more likely would rise. Central banks’ every word would remain forensically scrutinised. And there would be an accompanying demand for ever-greater amounts of central bank transparency. Central banks would rarely be far from the front pages. Which path?

Often, their role was to act as no more than an operational agent for the government of the day, managing money, debt and foreign exchange markets. They were agents, not principals. Through the course of the 20th century, central banks’ influence began to grow. So too did their numbers. For some, this evolution began with being granted monopoly rights over issuing legal tender – fiat money. This gave central banks special status relative to commercial banks. It underscored their stability role as liquidity provider to the banking system: stabilising short-term money markets in normal times, acting as lender of last resort in abnormal ones. It also secured, by fiat, a demand for central bank liabilities. This meant central bank money became the natural settlement medium, and central banks the natural clearing house, when discharging obligations among banks. As the marginal supplier of liquidity, this gave central banks the ability to set the marginal price of liquidity – the short-term interest rate. In that way, monetary policy was born and an important central bank step had been taken. The early phases of monetary control by central banks were often inauspicious, highly constrained, or both. Monetary regimes during the latter part of the 19th century and the first part of the 20th were long on rules and short on discretion. The Gold Standard, and later the Bretton Woods regime, tethered monetary policy to a commodity or dollar anchor, with little scope for monetary discretion. And where monetary discretion did operate, it was not always a success.