Working Papers No 448 May 2014. The exit from non-conventional monetary policy: what challenges? by Philip Turner

“Monetary policies pursued in response to the financial crisis have shown that changes in central bank balance sheets have major macroeconomic consequences. The New Classical Macroeconomics, which gained increasing sway from the late-1980s, had led to an exclusive focus on the policy rate and a neglect of balance sheet effects. Key financial market imperfections that had been demonstrated by earlier (or contemporaneous) advances in microeconomic theory were assumed away under the guise of Ricardian equivalence. Getting their balance sheets back to normal levels is important in order to preserve policy flexibility for the future, but will present central banks with formidable challenges. This task will require cooperation with Treasuries without surrendering monetary policy independence. As central banks pragmatically monitor market resilience, the financial dominance trap is to be avoided.”