The relationship between central banks and financial regulation: a critique of the mainstream consensus and elements for a post-Keynesian approach

Central banks manage monetary policy to achieve either price and/or output objectives and, also, supervise/regulate the financial system. Yet both functions have been traditionally dissociated from one another, at the macroeconomic level, with important consequences for financial stability. The separation and dissociation between both functions has its rationale in Neo-Walrasian Monetary Theory (NWMT) that was developed on the presumption that, in the absence of distribution effects, monetary policy could function without supporting financial regulation. The influence of the Neoclassical theory of finance (NTF) on macroeconomics strengthened the case for separation between both functions leading to the view that banks should either be unregulated or regulated like any other firm at the micro level. Capital adequacy standards (CAS) became the preferred form of regulation for banks. The change of focus from microprudential to macroprudential was a product of necessity, as CAS proved to be not only an insufficient deterrent to the occurrence of financial crises but became, also, an endogenous source of macroeconomic fragility and instability. However, the same views leading to the adoption of CAS have shaped the design and understanding of macroprudential regulation. The dissociation between the two functions of central banks, in theory and practice, has precluded any proper analysis of the role of financial intermediaries in the economy and of the relationship between monetary policy and financial stability.