No return to business as usual for central banks Innovative monetary policies used to fight the financial crisis will remain part of the central bank arsenal even when market conditions normalise, according to a report. Instruments such as quantitative easing (QE), long-term bond purchases and forward guidance are unlikely to be discarded, especially as central banks have now accepted responsibility for financial stability as well as low inflation. The report is based on papers by current and former central bankers and was issued by the International Centre for Monetary and Banking Studies (ICMB) in Geneva and the Centre for Economic Policy Research in London. Princeton University professor Alan Blinder, a former Federal Reserve vice-chairman, said balance sheet policies such as QE might be needed permanently if average inflation stays low and interest rates hit the zero lower bound (ZLB) more often. In such circumstances, monetary policy might be more effective if central banks not only controlled the overnight rate but also bought and sold medium and/or long-term bonds. "The case for operating across the yield curve is strengthened if you believe, as I do, that average inflation rates over the next, say, 50 years will be lower than they were over the previous 50," Mr Blinder said. One risk highlighted by the study, entitled 'Exit Strategy', is that unconventional monetary policy will endanger central bank independence by crossing the boundaries with fiscal policy. Former Fed governor Frederic Mishkin, a Columbia University professor, agreed that unorthodox policies should be retained because interest rates might keep hitting the zero bound. "However, because these non-conventional monetary policy tools entail costs that conventional tools do not, they probably should be brought out of the toolkit only when they are needed, that is, when negative shocks to the economy make the ZLB on interest rates a serious problem," he wrote. Benoit Coeure, a member of the executive board of the European Central Bank, said the bank's operational framework had given it enormous flexibility during the crisis. Some would argue that most of the new instruments might not be needed to the same extent once money markets return to normal. But is this so? Some elements of our current mode of operation have served us well, and not only as crisis management tools," Mr Coeure said. Lucrezia Reichlin, a professor at the London Business School and a former research director at the ECB, said the blurring of lines between monetary and fiscal policy was especially sensitive in the eurozone. In buying bonds of one member state, the ECB is assuming credit risk that other governments ultimately shoulder. Without clear rules governing the relations between the ECB and the eurozone's fiscal authorities, the ECB might be pushed to do too little because of fear of moral hazard or too much because governments sit on their hands. In the first case, the danger of a self-fulfilling liquidity crisis looms. In the second case, the ECB becomes a sort of institution of last resort that, rather than being independent, becomes sovereign. This would be dangerous, she said. "This type of sovereignty exercised by unelected officials will eventually be challenged and 30 years of good central banking practice, to which most attribute the conquest of inflation, will be undone," Ms Reichlin said.