MONETARY POLICY IN THE 215T CENTURY: AN IMPOSSIBLE TASK? Kevin Dowd One of the most obvious trends over the last two decades has been the gradual erosion of central bank power by market forces. Central banks are operating under ever tighter constraints as nancial markets become more integrated and more efcient, and as capital itself becomes more mobile and currencies become better substitutes for each other. Now, more than ever, central banks need to ensure that they-carry the markets with them if their policies are to have any chance of success. If they fail to do soif they engage in ill-judged attempts to manipulate interest rates or exchange rates, for example they leave themselves open to withering speculative attack on a scale that no central bank can withstand. As recent experience has shown, the nancial markets impose swift and merciless punishment on gov- ernments and central banks who try to defy them. Monetary policy has never been so constrained since the collapse of the Bretton Woods system in the early 1970s. A New Threat to Monetary Policy: The Falling Demand for Central Bank Money Central bankers also face a new and more dangerous threat. Long- run factorstechnological ones, in particularwill not only further reduce the effectiveness of monetary policy, but are likely to destroy it altogether. These new developments threaten to reduce the demand for central bank money (the monetary base) to a level where the central bank's leverage over the monetary systemwits ability to inu- ence interest rates, exchange rates, and the money supplyeffectively disappears. Cato journal , Vol. 17, No. 3 (Winter 1998). Copyright Cato Institute. All rights reserved. Kevin Dowd is Professor of Economics at the University of Shefeld. He thanks David Cronin for his helpful comments. 327