Central banks have been around a long time. The Bank of England celebrated its tercentenary in 1994. The even older Swedish Riksbank marks its 350th anniversary this year. But the modern independent central bank is a relatively new development that started for the most part in the 1990s. The European Central Bank, the most autonomous of all, was born at the start of June 1998, exactly 20 years ago. Now there is disquiet among central bankers that their golden age of monetary independence may prove to be as transient as previous eras such as the late 19th century gold standard.
These concerns were aired in a conference held on 25thMay in Stockholm to mark the Swedish central bank’s 350-year history. Jerome Powell, since February the Chairman of America’s Federal Reserve (a stripling by comparison, barely more than a century old), said that this was “a challenging moment for central banking.” Noting that trust in government and public institutions was at historic lows, he added that “central banks cannot take our measure of independence for granted.”
If a backlash is coming against central banks, the surprise is that it has taken so long. For in truth the golden age of monetary independence ended a decade ago, with a bang. The charge against central bankers is straightforward. The worst financial crisis since the early 1930s occurred on their watch, after they had been handed the keys to managing the economy.
Whatever their success in achieving price stability, which was probably overstated given underlying secular disinflationary forces from technology and globalisation, central banks spectacularly failed to achieve financial stability. Yet that was traditionally just as crucial a mission. As early as the 1870s, Walter Bagehot had formulated in Lombard Street the Bank of England’s indispensable role as lender of last resort in order to thwart bank runs. The Fed for its part was created in 1913 after a succession of banking panics in America in order to prevent further financial instability.
Extraordinarily, central banks paid no price for their collective failure. Far from it: they emerged from the financial crisis even more powerful than before. The Bank of England regained the banking supervisory role that it had lost in 1997 when the newly elected Labour government made it independent in monetary policy. As if that was not enough it now also supervises insurers, helping to explain why Mark Carney highlights the financial risks of climate change. The Bank’s Governor is kept busy since he also chairs the Bank’s committee that oversees financial stability and deploys “macroprudential” tools such as raising banks’ capital ratios in order to rein in excessive lending. The ECB similarly won sweeping new powers as European governments put it in overall charge of supervising eurozone banks, a task it assumed in late 2014.
Most important of all, central bankers have boldly gone where none had gone before in their key domain of monetary policy. By making massive purchases of government bonds with newly created money, they have driven up their prices and lowered their yields (which move inversely). As investors have sought higher yields in riskier assets such as equities that has in turn pushed up their prices. The policy of quantitative easing may have helped to stimulate moribund economies after the crisis but it has done so by making already rich owners of financial assets richer still. At the same time poorer savers who rely on bank deposits have been getting next to nothing.
“Central banks are camped in treacherous territory where their choices have lasting distributional effects”
Central banks no longer occupy the firm ground of conventional policies where winners and losers alternate according to the economic and interest-rate cycle, with borrowers losing and savers gaining when short-term rates go up and the converse occurring when they come down. Instead they are camped in treacherous territory where their choices have lasting distributional effects since their unconventional policies have held both short-term and long-term interest rates so low for so long.
There are plenty of good arguments that central bankers can muster in their defence. For one thing, their new regulatory powers have been thrust upon them by politicians anxious to show they are striving to avoid another crisis while also blaming their predecessors for what went wrong. Whatever the merits and demerits of George Osborne’s decision to repatriate banking supervision to the Bank of England, it certainly made political sense. And if central banks have taken monetary policy to its outer limits and beyond that reflects the reluctance of austerity-minded governments to use fiscal policy. Moreover, they can point to the beneficial impact of quantitative easing in boosting GDP and jobs.
But in the trial of public opinion these arguments are unlikely to count for much if central bankers come to be seen as too big for their boots. Paul Tucker, a former Deputy Governor of the BoE and now a fellow at the Harvard Kennedy School, confronts this issue in his weighty new book, Unelected Power. Setting central banks in the broader context of independent agencies exercising delegated authority, he endorses the reinforcement of central bank power in the domains of banking supervision and financial stability. What this means, he argues, is that they have to work harder at explaining what they do: “central bankers need, continuously, to be legitimacy seekers.” At the same time they must avoid the temptation to sound off about issues outside their core mandate: “Because central banks are so very powerful, there is a need for an ethic of self-restraint, underpinned by informal conventions and norms.”
Central bankers have no difficulty in swallowing this mild prescription. In his Stockholm speech, Powell said that central banks are “assigned narrow but important mandates.” The Fed chief declared that “public transparency and accountability around both financial stability and monetary policy have become all the more important in light of the extraordinary actions taken by central banks in response to the global financial crisis.” He cited the new regime of stress-testing banks as “itself a step forward in transparency.”
Powell’s claim that central bank mandates are narrow is disputable. But the bigger doubt is whether the admirable sounding remedy of transparency and accountability will be sufficient to protect central bank independence when economies turn down and hidden financial weaknesses are exposed. Central banks will be particularly vulnerable if the pumping-up of asset prices through quantitative easing turns out to have been too much of a good thing. For the ECB, the continuing fragility of a monetary union without a corresponding fiscal and political union remains a recurring threat as the recent turmoil in Italian financial markets shows.
Central banks in advanced economies devoutly want to “normalise” policies so that they can return to the safer ground of conventional policymaking. The worry is that there may be no easy path back, potentially putting their worthy independent status in jeopardy.
Unelected Power: The Quest for Legitimacy in Central Banking and the Regulatory State, Paul Tucker, (Princeton University Press)