The world's central bankers need to do more if the global economy is to avoid a repeat of the current financial debacle, the governor of the Bank of Canada said Wednesday.

Mark Carney told an audience in London, England, that central banks have to move beyond merely controlling inflation as their raison d'etre.

Instead, the public institutions need to act more aggressively to ensure the important lending markets remain in operation, especially during times of crisis, he said.

"The … strategy requires central banks to act as market-maker of last resort. That is, central banks would ensure that market transactions continue in times of crisis .… This would address directly the current fear of non-bank participants in many global money markets that they will not be able to continuously access liquidity," Carney told an audience at the United Kingdom Chamber of Commerce.

One reason for the current global economic crisis is that important financial markets, such as the one for asset-backed commercial paper, seized up as investors lost confidence in the worth of the underlying securities.

Beyond inflation

Once this specialized — but important — credit market stopped working, financial institutions had to find other forms of capital to shore up their listing balance statements. As more and more banks and other organizations found themselves facing a financing crunch, however, potential lenders disappeared, worsening their economic predicament even further.

Central banks responded by cutting interest rates and pumping trillions in new liquidity into the global financial system. Both responses, however, still haven't managed to turn equity markets and business sentiment positive.

Carney said central banks actually could step in to act as a buyer and seller of last resort for such toxic assets. Then, as private sector participants regain confidence in these instruments, then the financial instruments will regain value and be traded actively once again, he noted.

"We have a financial system that affords us the means, and gives us the prospect, of investing for the inevitable global recovery. For that recovery to reach its full potential, we all need a financial system with continuously open markets at its core," Carney said.

Changing the focus

Some experts have argued, in the past, that the major central banks, such as the Bank of Canada and the U.S. Federal Reserve, centered their policies too much on fighting inflation and not enough on other aspects of the financial system, such as credit markets.

Carney pointed out that, while effective, the central bank's focus on the overall price levels in a country do little to reduce excessive speculation in specific areas, such as the formerly super-heated housing market in the United States.

"One clear lesson is that price stability alone is not sufficient to prevent the buildup of macroeconomic imbalances," Carney said. "Indeed, asset bubbles frequently emerge during periods of low and stable consumer price inflation."

Because the central bank emphasized inflation, however, many market watchers continued to anticipate further interest rate cuts even though such reductions appear to have had little effect on equity markets and future GDP growth projections.

For instance, the economics department of the Toronto-Dominion Bank currently predicts that North America's three economies will grow a total of 0.1 per cent in 2009.

The bank's feeble projection for economic growth is in the face of TD's forecast that the U.S. Federal Reserve will cut rates to 0.50 per cent in 2009 from 2.25 per cent in early 2008 and the Bank of Canada will chop its overnight lending rate to 1.75 per cent in 2009, compared with the 3.50 per cent level that prevailed in the first quarter of 2008.

More regulation?

In Carney's world, central banks and financial regulators need to become more aggressive in regulating various financial institutions.

"It will not be enough for prudential regulators to adopt new measures within their current frameworks. There needs to be oversight of the system as a whole — including both systemically important institutions and systemically important markets. This oversight may be best housed in those public institutions with a macroeconomic orientation," he told the London audience.

While Carney's suggestion stopped short of calling for a global financial regulator or placing more power placed in the hands of central bankers, a country's monetary authority, whether it be the Bank of England, the Bank of Canada or the European Central Bank, is usually regarded as the national institution with the broadest economic outlook.