Five year after the crash, why are central bankers back in the driver's seat?by Alasdair Roberts / May 28, 2013 / Leave a comment
In May 1932 Franklin Roosevelt was governor of New York State, and seeking the Democratic Party’s nomination for president. At Georgia’s Oglethorpe University, he described the philosophy that would guide a Roosevelt White House. “The country needs bold, persistent experimentation,” Roosevelt said. “Take a method and try it. If it fails, admit it frankly and try another. But above all, try something.”
Experimentation. This is what the Roosevelt administration, working with the U.S. Congress, undertook during the Great Depression. American politicians launched an alphabet soup of programs — NIRA, TVA, AAA, WPA, PWA, REA, and many more. Some succeeded and many failed. But at least the political class had tried something, as Roosevelt insisted. Together, they replied firmly to skeptics who said that democratic institutions were incapable of responding effectively to the economic crisis.
Eighty years later, we are in the midst of another crisis. But politicians in the United States and Britain are not seized with the spirit of experimentation. On the contrary, the prevailing mood is one of caution. In the field of fiscal policy, for example, politicians have largely avoided significant initiatives to stimulate recovery. On both sides of the Atlantic, elected officials have been immobilized by the fear of failure — specifically, by worry that large-scale stimulus programmes might do more harm than good.
Some economists have stoked that fear, arguing that under conditions of uncertainty the best policy is one of caution. The benefits of stimulus are indefinite, Harvard professor Kenneth Rogoff argued in a 2010 column in the Financial Times. At the same time, he added, it would be “folly to ignore the long-term risks of already record peace-time debt accumulation . . . An apparently benign market environment can darken quite suddenly.”
Just about the only domain in which there has been substantial experimentation since 2008 is monetary policy. For example, the Bank of England and the Federal Reserve have purchased massive amounts of government-issued debt, in an attempt to suppress long-term interest rates and stimulate recovery. Central bankers recognise that there are substantial risks associated with this policy, commonly known as quantitative easing. Inflation could spike sharply upward once recovery begins, and asset bubbles could be created as investors search for higher returns. Still, central bankers have not been deterred by the risks. Instead, they have rolled the dice.
At first glance this might suggest that the spirit of 1932 is alive and well. Vince Cable, the Secretary of State for Business, Innovation and Skills, sounded like Roosevelt when he explained quantitative easing last year. “This is an experiment,” Cable said. “We don’t know where it is going to lead. . . but my judgment when I was first confronted with this was that it was something that we had to try, because the alternative was probably a disaster.”
But Cable is not Roosevelt, and 2013 is not like 1933. The decision to pursue quantitative easing did not belong to him, or any other member of the British Cabinet. The Bank of England was given formal independence in 1997, and it alone decided whether to undertake this experiment. The same is true of the Federal Reserve, which is formally independent of the White House and the U.S. Cabinet.
Similarly, central bankers alone will decide when their experiments end. Indeed, one of the main reasons why central bankers have been willing to pursue unconventional policies is that they have full confidence in their ability to reverse course before the risk of failure becomes too large. As Federal Reserve chairman Ben Bernanke explained last summer, the US central bank “has spent considerable effort planning and testing our exit strategy, and will act decisively to execute it at the appropriate time.”
The same air of confidence was evident in Bernanke’s testimony before Congress on May 22. Once again, Bernanke acknowledged the “costs and risks” associated with current Federal Reserve policies. But he expressed little doubt about the central bank’s ability to manage the risks competently. Instead, Bernanke promised that the Federal Reserve’s experiments would be subject to “recalibration… in light of incoming information.”
The current experiments in monetary policy are proof of the enduring power of the technocratic class that dominates central banking. We might be surprised by this. Faith in central bankers, and the scholarly economists with whom they are now closely allied, was badly shaken immediately after 2008. Queen Elizabeth caught the public mood when she asked why economists had not seen the crisis coming. (The difficulty, the British Academy responded, was “a failure of the collective imagination of many bright people.”) The assault on central bankers was harsher in the United States, where Representative Ron Paul’s book End The Fed became a bestseller.
Why are central bankers back in the driver’s seat? Because trust in politicians is even more badly damaged. Again, the debate over stimulative fiscal policies illustrates the problem. A substantial amount of discussion over stimulus has appeared to hinge on narrow empirical questions, such as the likely impact of additional government spending, or the effect of debt once it reaches a certain level. But these empirical debates are a distraction.
The real question is whether politicians can be trusted to exercise discretion over fiscal policy at all. Fiscal policy is not like monetary policy, which is run by technocrats. Politicians alone make decisions on taxing and spending. If we insist on simple policy rules, like balancing the budget, then we tie the politicians’ hands. We limit their capacity to do good, but we also limit their capacity to behave badly. If we acknowledge the legitimacy of stimulative policies, on the other hand, then we give politicians more room for maneuvre. Politicians alone will decide how big the stimulus will be, and when it will end.
The underlying problem is that most of the technocratic class, as well as a large number of voters, no longer trust politicians to exercise this discretion properly. They do not believe that politicians would “recalibrate in light of incoming information,” to borrow Ben Bernanke’s phrase. And they have good reason for skepticism. The average American or British voter has never seen a prolonged period of substantial debt reduction. What they have seen is a succession of schemes — such as balanced budget laws and fiscal policy codes — that have largely failed to deliver long-run discipline on taxing and spending.
As a result there is no appetite for experimentation by politicians. On the contrary, we insist on austerity, even though it hurts us in the short run. And we leave the pursuit of unorthodox policies to central bankers — not because we are enthused by technocratic governance, but because we lack any appealing alternatives. So far as the formulation of macroeconomic policy is concerned, democratic governance has been put into receivership.