In an earlier post I discussed the various pressures on central banks and threats to their independence. For the most part, however, central bankers shied away from bemoaning the state of affairs some of them find themselves in. This is changing. At the Allied Social Sciences Association conference held in January, there were two sessions on the topic of central bank independence. In one of these sessions, James Bullard, President of the Federal Reserve Bank of St. Louis remarked that central banks were increasingly becoming politicized. Jens Weidmann, President of the German Bundesbank, complained in a recent speech that central bank independence was "at risk." Indeed, he went on to worry out loud about “…an increasing politicisation of the exchange rate.” Remarks such as these have sparked renewed concerns over the prospect of a "currency war."
For the last few years there has been a noticeable drop in interest in the topic of central bank independence. Now, in the aftermath of the twin financial crises in the U.S. and the eurozone the role of central banks, and central bankers, has been elevated to the top of the policy making challenges faced by the global economy. Events, to paraphrase Sir Mervyn King, Governor of the Bank of England, thwarted central bankers’ ambition “to be boring.” It should not escape one’s notice that the Governor’s words were uttered in early 2007, mere months before everything changed for the world economy and monetary policy (you can find his speech on BIS).
Rather unexpectedly, central banks have taken on more policy-making responsibilities. Monetary policy, it seems, is no longer just about ensuring price stability, with an aim to mitigate the variability of business cycles, but macro-prudential responsibilities are now increasingly being thrown into the mix, alongside any micro-prudential responsibilities they may have had or have acquired since the events of 2007. These developments have taken place in spite of the fact that some key central banks — such as the U.S. Federal Reserve, the Bank of England, and the European Central Bank — were reportedly slow off the mark when financial markets began their meltdown, their forecasting performance was severely criticized, or they initially waved off requests for more intervention for fear that they might be violating their mandate. For example, recently released FED transcripts from 2007 suggest that Federal Open Market Committee (FOMC), the Fed’s policy making body, was struggling to understand the implications of the economic slowdown taking place in parallel with dropping housing prices. By August 2007, when the sub-prime crisis was beginning to take hold, some FOMC members felt that what was happening in the sub-prime market was beneficial; “Basically what I think is happening in a way is quite a good thing” (FT, January 19, 2013). Former Fed governor Frederic Mishkin felt this way because the events unfolding would correct the impression some in the Fed had about the market being “…a little too optimistic, that there was too much opacity, and that people weren’t worried about it” (2013) Donald Kohn, former vice-Chair of the FOMC remarked that the economic troubles brewing would imply that “[T]he most likely outcome is that it will be limited in duration and effect…” (2013). Now, in the sixth year of the crisis, we wonder how long central banks will delay the inevitable exit they someday promise will take hold. And, if it ends badly, will they be rewarded with having to shoulder an even heavier burden for policy-making or will the politicization of central banking become complete?
So, are all the complaints about the loss of central bank independence justified? Or, are the central bankers crying crocodile tears? The latter seems closer to the truth. Even if we agree that the ‘do whatever it takes’ attitude, whether to protect the economy or preserve the euro, is justified on the grounds that public officials have a responsibility to maintain economic stability, it must surely be the case that these same officials recognize that their actions also have consequences. Many have commented about how ultra low interest rates are repressing financial markets, or how policies that provide unlimited backing to banks and sovereigns actually worsens the moral hazard problem they have been trying to avoid. Nevertheless, one important implication of the series of actions taken by major central banks has been to abandon their policy of ‘doing no harm’ by overtly influencing real and financial activity in a manner that appears to go well beyond their usual remit.
“Today most central banks are independent, headed by non-elected officials, and quite powerful. This set-up is acceptable only if independence is limited by the mandate. That’s the framework the legislators have given us […]. That is why we are so keen about respecting the mandate, because that’s the true guarantee of our independence, which […] is crucial for our credibility. And credibility is essential for delivering price stability.” These are the words of Mario Draghi, President of the European Central Bank, uttered during a 2012 year end interview. Presumably, the ‘mandate’ he is referring to, is price stability. Nowhere is financial stability or banking supervision mentioned. Yet, it is doubtful that the panoply of interventions by the ECB, most recently its promise to buy sovereign debt under certain conditions (the so-called Outright Monetary Transactions program), is what legislators had in mind when they created the multi-national central bank.
While some central bankers bemoan the threat to their independence and assert that limiting a central bank’s mandate is the best way to preserve the credibility that underscores their ability to autonomously implement monetary policy, as a group, they seem to be all too willing to accept greater responsibilities even before they have a clear understanding of how they can be held to account for policies introduced in areas where we have little understanding about the consequences of central bank actions. As a recent paper by the IMF concludes, focusing on the role and influence of macro-prudential policies, we know precious little about the consequences of monetary and macro-prudential policies interacting with each other while central banks tout their importance to the maintenance of financial stability. Instead of emphasizing that, in times of crisis, coordination of policies and actions between central banks and governments is critical, they have allowed politicians to offload some of their responsibilities for macroeconomic and financial policies to the ‘unelected’ monetary authorities. As a result, we are likely to see more threats to central banks’ place in the policy-making community of the kind that led to U.S. Congressman Ron Paul’s End the Fed campaign. In the meantime don’t feel too sorry for the central bankers, they seem to have more or less willingly accepted this state of affairs.