The New Lombard Street by Perry Mehrling

Last updated: Sep 1, 2023

Summary of The New Lombard Street by Perry Mehrling

The New Lombard Street by Perry Mehrling is a comprehensive analysis of the modern financial system and the role of central banks in managing it. The book explores the evolution of the financial system from the traditional Lombard Street, the financial hub of London in the 19th century, to the current global financial system.

Mehrling argues that the financial system has undergone significant changes since the time of Walter Bagehot, who wrote Lombard Street in 1873. He highlights the shift from a system based on commercial banks and their ability to create money through lending, to a system dominated by investment banks and shadow banking institutions.

The author emphasizes the importance of understanding the interplay between money and credit in the modern financial system. He explains how money, traditionally seen as a medium of exchange and a store of value, has become intertwined with credit, which is the ability to borrow and lend. Mehrling argues that this interplay between money and credit is crucial for understanding the functioning of the financial system and the role of central banks.

Mehrling also delves into the role of central banks in managing the financial system. He discusses the concept of a lender of last resort, which was introduced by Bagehot in Lombard Street. The author argues that central banks have expanded their role beyond being lenders of last resort to becoming market makers of last resort. He explains how central banks now intervene in financial markets to provide liquidity and stabilize the system during times of crisis.

The book also explores the challenges faced by central banks in the modern financial system. Mehrling discusses the limitations of monetary policy and the need for a more comprehensive approach to financial stability. He argues that central banks should focus not only on managing interest rates but also on regulating the financial system and addressing systemic risks.

In conclusion, The New Lombard Street provides a comprehensive analysis of the modern financial system and the role of central banks. Mehrling highlights the evolution of the financial system from the traditional Lombard Street to the current global financial system, emphasizing the interplay between money and credit. The book also explores the role of central banks as lenders and market makers of last resort, as well as the challenges they face in managing the financial system. Overall, it offers valuable insights into the functioning of the modern financial system and the role of central banks in maintaining stability.

1. The Role of Central Banks in the Modern Financial System

In "The New Lombard Street," Perry Mehrling explores the role of central banks in the modern financial system. He argues that central banks have evolved from being lenders of last resort to being market makers of last resort. This means that central banks not only provide liquidity to the financial system during times of crisis but also actively intervene in financial markets to stabilize them.

Mehrling explains that central banks now play a crucial role in managing the overall liquidity of the financial system and ensuring the smooth functioning of financial markets. This insight is actionable for policymakers and investors as it highlights the importance of closely monitoring central bank actions and policies to understand their impact on financial markets and the broader economy.

2. The Interplay Between Money and Credit

Mehrling delves into the interplay between money and credit in "The New Lombard Street." He argues that money and credit are not separate entities but rather two sides of the same coin. Money represents the medium of exchange, while credit represents the promise to repay that medium of exchange in the future.

This insight is profound as it challenges the traditional view that money and credit are distinct and independent. Understanding the interplay between money and credit is crucial for policymakers and economists to effectively manage monetary policy and financial stability. It also provides a fresh perspective for investors to analyze the relationship between money supply, credit availability, and economic growth.

3. The Importance of Market-Based Finance

Mehrling emphasizes the importance of market-based finance in "The New Lombard Street." He argues that traditional banking, with its focus on deposit-taking and lending, is no longer the dominant force in the financial system. Instead, market-based finance, which includes activities such as securities lending, repo markets, and money market funds, has become the primary source of funding for many institutions.

This insight is original and challenges the conventional view that banks are the main drivers of the financial system. Understanding the dynamics of market-based finance is crucial for policymakers and regulators to effectively monitor and manage systemic risks. It also provides valuable knowledge for investors to navigate the complexities of the modern financial landscape.

4. The Role of Shadow Banking

Mehrling explores the role of shadow banking in "The New Lombard Street." He argues that shadow banking, which refers to financial activities conducted outside the traditional banking system, has become an integral part of the modern financial system. Shadow banking entities, such as hedge funds and special purpose vehicles, play a significant role in intermediating credit and providing liquidity.

This insight is actionable for regulators and policymakers as it highlights the need to closely monitor and regulate shadow banking activities to ensure financial stability. It also provides valuable knowledge for investors to understand the potential risks and opportunities associated with shadow banking entities.

5. The Impact of Financial Innovation

Mehrling discusses the impact of financial innovation in "The New Lombard Street." He argues that financial innovation, such as the development of new financial instruments and technologies, has transformed the financial system and created new risks and opportunities.

This insight is profound as it highlights the need for policymakers, regulators, and investors to adapt to the changing financial landscape and understand the potential implications of financial innovation. It also emphasizes the importance of continuously monitoring and assessing the risks associated with new financial products and technologies.

6. The Role of Central Bank Communication

Mehrling emphasizes the role of central bank communication in "The New Lombard Street." He argues that central banks' communication strategies and statements have a significant impact on financial markets and investor behavior.

This insight is actionable for central banks and policymakers as it highlights the importance of clear and transparent communication to manage market expectations and maintain financial stability. It also provides valuable knowledge for investors to interpret central bank communications and make informed investment decisions.

7. The Need for Macroprudential Regulation

Mehrling discusses the need for macroprudential regulation in "The New Lombard Street." He argues that traditional microprudential regulation, which focuses on the safety and soundness of individual financial institutions, is insufficient to ensure overall financial stability.

This insight is original and highlights the importance of adopting a systemic approach to regulation that considers the interconnectedness and vulnerabilities of the entire financial system. It provides actionable guidance for regulators and policymakers to implement macroprudential measures to mitigate systemic risks and prevent future financial crises.

8. The Role of Financial Markets in Allocating Capital

Mehrling explores the role of financial markets in allocating capital in "The New Lombard Street." He argues that financial markets, through their pricing mechanisms and information dissemination, play a crucial role in efficiently allocating capital to productive uses.

This insight is profound as it emphasizes the importance of well-functioning financial markets in supporting economic growth and development. It also highlights the need for policymakers and regulators to ensure the integrity and efficiency of financial markets to facilitate capital allocation. For investors, understanding the role of financial markets can help inform investment decisions and identify potential opportunities.