The Case for a Global Central Bank

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Had such oversight existed before Lehman Brothers' collapse, the credit crisis might have been far less cataclysmic.

Another job: setting standards for debt-to-equity ratios for the biggest institutions. Past efforts, accords known as Basel and Basel II, took ages to conclude and were outdated before the ink was dry. We need a sustained process for pushing banks to acquire more reserves in boom times, the better to weather the inevitable downturns.

Currently, no central bank or finance ministry has the ability to look at such key determinants of growth and stability around the world, let alone the clout to sound alarms that would be heeded. (Or the motivation: The tendency is to try to give one's own institutions an edge.) But if a global central bank had existed before the meltdown, banks might not have been free to take on $35 of debt for every $1 of equity—and much less deleveraging would thus have been required in the crisis' aftermath. So lending in the past 18 months would have been less restrictive.

Finally, a worldwide central bank would engage in crisis simulation—running scenarios to heighten awareness of new dangers and sharpen the responses of government and private financial players. Such exercises in 2005-07 might have helped us anticipate how quickly a problem such as the subprime mess could spread. We are still desperately in need of such war-gaming. A new crisis could emanate from China's opaque financial system. Or we may need to prepare for a major currency debacle as Washington acquires trillions in new debt without a visible way of servicing it beyond devaluing the dollar.

Now for what a global central bank wouldn't do, at least until it was well established: It wouldn't create a global currency but would manage instead a world of dollars, pounds sterling, euros, yen, and renminbi. It wouldn't set monetary policy for individual nations, leaving that to existing central banks. Other questions remain, of course. To whom would this global regulator be accountable? How would it be funded? What would be its relationship to the IMF and the Bank for International Settlements (a club for central banks, albeit it a weak one)?

Outside of finance, the world has already moved toward stronger global institutions. Without a World Trade Organization, bringing China into the global trading system and managing its growing clout would have been much tougher. Absent a World Health Organization, we could not have contained SARS and other epidemics. And soon we'll need a world environmental agency to deal with climate change and other issues that far exceed the governing capacity of any one country.

Unfortunately, we are probably years away from high-level discussions about a global central bank. At its meeting the G-20 won't announce the formation of a panel of experts to study the idea. But it could do worse than create such a commission at some point. Sooner or later—perhaps after the next crisis, or the one after that—there will be an acknowledgement that the time has come for a global central bank.

Jeffrey E. Garten is the Juan Trippe Professor of International Trade & Finance at the Yale School of Management.

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