Time To Rein in Central Banks
Introduction
Central bank independence is highly controversial. An unelected group of officials have immense authority over the economy of the country, such as borrowing costs. This naturally raises the issue of legitimacy and the pitfalls of concentrating power in the hands of a select few.
Central bank independence was initiated against the backdrop of long and sustained periods of inflation in the 1970s and 1980s. One of the main arguments for independence was to prevent central bankers from succumbing to political pressures when determining monetary policy. In the past, central bankers had been reluctant to take measures to curb inflation in the face of political pressure to keep unemployment low and output high.
Today, central bank independence can take on many forms. However, they usually have a few definitive characteristics. First, a central bank is viewed as independent if its Governor or Chief is appointed by a board rather than someone from the government (such as the Prime Minister or Finance Minister). Second, the bank has a higher degree of independence if it can enact monetary policy independent from overt government influence. Third, legislation limits the amount of money the government can borrow from the central bank.
In practice, many central banks do not check all the boxes on independence. In the UK, inflation targets are still decided by the government while the Fed has substantial liberty of interpretation of the charter that sets its goals. The ECB is mandated with keeping price stability but again, it is free to interpret this concept as it wishes. On the other end of the spectrum, the Swiss National Bank, deemed by many as one of the most independent central banks in the world, informed the Swiss government of its decision to abandon the Franc-Euro peg in 2011 only a few hours before they made an official announcement, thus demonstrating the autonomy that the Swiss National Bank has over its decision making.
Are central banks going beyond their mandate of maintaining price stability?
Central banks have been criticised for interfering with politics and government policy. In the US, President-Elect Trump repeatedly criticised Federal Reserve Chairperson Janet Yellen’s during the presidential campaign alleging that the Fed was getting too political. More recently, British Prime Minister Theresa May (who worked at the Bank of England for a few years before entering politics) also appeared to criticise him at her party conference this year by claiming many savers had suffered as a result of his low-rate policy. The question remains - are central banks going beyond their mandate of maintaining price stability?
From rate cuts and quantitative easing (QE) in Europe, to stimulus packages in China and Japan, 2016 has been a busy year for central banking activity. However, many of these activities goes far beyond the core mandate of growing inflation steadily, resorting instead to engaging in activities that maintains an illusion of growth. For example, the Bank of Japan resorted to massive purchases of corporate bonds and stocks. This is problematic on multiple levels. Inserting liquidity into markets in the form of 'stimulus' appears to be a quick and easy fix to jolt the economy. However, such actions could very well lead to an even larger asset bubble than 2008. From here, a vicious cycle would ensue - more central bank intervention as the global economy trudges from one crisis to the next.
This also sets a dangerous precedence of purchases extending to other asset classes, a slippery slope that even the Fed has missed. During a speech in August 2016, Janet Yellen seemed to support the idea of more ‘stimulus’ packages: “on the monetary policy side, future policymakers might choose to consider some additional tools that have been employed by other central banks, though adding them to our toolkit would require a very careful weighing of costs and benefits and, in some cases, could require legislation. For example, future policymakers may wish to explore the possibility of purchasing a broader range of assets”. If this trajectory continues, we could even have central banks owning European football clubs or emerging as asset managers or private equity investors. In reality, this has lead to stock markets being artificially capitalised by central bank money, rendering a true and fair stock market price and by extension the health of the economy nearly impossible to determine. The end result is something completely unimaginable only a decade ago: interest rates at low or negative levels, central bank ownership of everything from the debt of Assicurazioni Generali (ECB) to stock of Microsoft and Apple (SNB).
The case for more control
Ineffective central banking policies over the past decade have led to calls in some countries to rein in independence.
One argument for more control over central banks is the lack of policy tools in a liquidity trap. An independent central bank serves a critical purpose to counter the problem of time consistent politics: that policymakers will not make good in future on policy promises made today. While effective during times of stable inflation and economic growth, this relationship seems to be broken today with the bag of tricks a central banker uses to form policy effective empty, especially with many countries approaching or already at the zero lower bound problem.
Another argument is that the traditional barrier that should exist between a central bank’s ability to print money and a government’s ability to spend it to avoid problems such as hyperinflation has blurred. In a time of loose monetary policy, central banks have been purchasing government bonds at record levels, blurring the line between fiscal and monetary policy as government debt is usually the asset by which a country’s monetary base is set. This runs contrary to one of the reasons why central banks were meant to be independent institutions in the first place.
Finally, a more recent criticism that has emerged is the perceived political interference of central banks. British PM Theresa May was right when she said that the Bank of England’s low rate policy helped borrowers but hurt savers. Should wealth distribution be a political question handled by politicians and not unaccountable ‘technocrats’ is a valid question that policymakers and central bankers should be asking. After all, the political and social consequences of central banking policies are not usually rigorously benchmarked.
A suggestion to governments
Independent central banks exists to separate monetary and fiscal policy. In practice however, such a separation is never completely ‘clean’ because every monetary policy action has fiscal consequences and vice versa. This presents an opportunity to challenge the notion of completely independent central banks. Given the limitations and ineffectiveness of monetary policy tools today, it is time to curb some of the autonomy currently enjoyed by central banks.
Governments can consider coordinating the actions of a central bank under the direction of an elected government towards a stated objective within pre-defined terms and legislative oversight. This principle draws inspiration from Cicero, a Roman philosopher and lawyer who popularised the idea of Inter arma enim silent leges – in times of war, the law falls silent. In Ancient Rome, democracy was suspended during times of crisis to allow a dictator to assume power for expedient decision making. In today's context, increased governmental control over monetary policy would allow objectives such as increasing output, supporting prices, fiscal spending and inflation to be achieved as effectively and efficiently as possible with fiscal and monetary policy working in tandem.
This idea may seem radical to some, especially with the consequences and memories of hyperinflation in Europe still fresh. However, it is imperative to understand the different roles an independent central bank plays in an inflationary or deflationary environments. During times of inflation, an independent central bank is required to say 'no' to unscrupulous politicians happy to create money out of thin air. During periods of extremely low inflation and interest rates, coordination of monetary and fiscal policy is necessary as excessive money creation is not likely to be the problem. Given the economic climate we find ourselves in today, inflation targeting policies would likely be the objective, an ideal situation for this suggestion to work.
While some may argue that we would re-create problems that an independent central bank was supposed to solve (e.g hyperinflation, reckless government spending), cooperation between monetary policymakers and fiscal policymakers does not necessarily run contradictory to the independence of central banks. In fact, it is similar to the relationship that two countries would have when pursuing a common economic objective - national sovereignty is still maintained. The only question is to what extent monetary and fiscal policies need to be coordinated from an institutional standpoint.
Conclusion
Central bank independence was created to solve an issue that no longer exists in developed economies: rampant inflation. After years of aggressive monetary policies worldwide, inflation is nowhere to be found. As such, this presents the case for reining in central banks with greater governmental oversight. If independent central banks continue to wield unaccountable power and pursue independent policies from their ivory towers, the new normal for the global economy might very well be what the Japanese economy has experienced since the 1990s - deflation coupled with anemic economic growth.
WRITTEN BY ANDREA LIVERANI & FELIX LIM FOR BESA
PLEASE DIRECT ANY INQUIRY TO AS.BESA@UNIBOCCONI.IT
