Governments could take away powers
by Andrew Large
Central banks have been in the firing line lately – and the challenges will grow more severe, especially in the US, after the election of Donald Trump. In retrospect central bankers would have been wiser, upon taking on increased mandates after the global financial crisis, to be more assertive about what they could and could not achieve. They should have been firmer in pointing out where structural or governmental fiscal measures would have been preferable to monetary actions.
If central banks fail these challenges, they risk governments stripping them of their enlarged powers.
Central banks need to demonstrate some humility. Although much has been achieved in monetary policy, and since the global financial crisis in financial stability as well, there is much that neither central banks nor the rest of the world understand. Moreover, central banks need to improve their communications strategies. They must inspire confidence. To do this they should be careful to communicate only what they know they can achieve.
Trade-offs for central bank mandates
In democracies, there is always tension over placing power in the hands of unelected officials. This extends to the authority exercised by central banks. However, the delegation of powers has long been regarded as legitimate for the traditional central bank function of acting as lender of last resort.
In the latter decades of the 20th century, monetary policy came within central banks’ remit, and was accorded political legitimacy, for two basic reasons. First, central banks could be held accountable, since the results of policy actions in terms of inflation and price stability were observable and measurable. Second, it was understood that monetary policy would improve if conducted by those with the requisite economic expertise.
The inconsistency of giving central banks delegated powers, with objectives set by politicians, was seen as preferable to politicians or any other party trying to do the job. However, this consensus has come under strain in many jurisdictions including the US, the euro area, Japan, and the UK.
Targets for perceived failures
The No.1 reason concerns the widening of central banks’ mandates. ‘Too much power’ raises hackles and makes central banks targets for perceived failures. Although varying across jurisdictions, policy areas now within the formal ambit of central banks include prudential regulation of a complex financial sector; conduct of both customers and markets; and, most significantly, responsibility for underpinning financial stability.
The latter requires policies for macroprudential activity designed to provide early warnings and mitigate threats; being satisfied that banks and other financial institutions and infrastructure are stronger and more resilient; and ensuring that, if there are failures, the mechanisms are in place to reduce their impact and cost.
One big problem here is that financial stability outcomes cannot be measured as price stability and inflation can. Central banks don’t know if they have failed until it is too late. The costs of avoiding failure can be substantial. Additionally, where central banks are dealing with complex financial systems,
the danger of confusion and policy conflict is ever-present – threatening damage to central banks’ overall credibility.
A second reason for the strains is the complications stemming from interest rates at zero or below. Policy actions intended to get inflation back to target have demonstrated that central banks are finding difficulty in achieving their remit. Quantitative easing has introduced asset price distortions that have benefited some at the cost of others. Moreover, QE comes ultimately closer to a fiscal dimension which is normally the prerogative of politicians, not central banks.
Third, macroprudential policy choices inevitably have selective impact, perhaps more so than interest rates in the case of monetary policy. For example, home-buyers, or their lenders, may be selectively affected. And where people object, in the absence of hard evidence that the actions were necessary, politicians will listen.
The fourth reason is the rise of populist politics. Such movements tend to denigrate the establishment, decry its expertise, and suggest that its policies are politically motivated. Central banks with their delegated powers are not exempt from these rebukes.
One big nagging question remains: Who could do a better job? No one is suggesting that price stability, inflation and financial stability do not matter: quite the opposite. Politicians may feel that they can somehow do better, but the historical record is not on their side.
Central bankers need to continue with their central mandates, while becoming more adept at mastering the challenges that accompany their increasingly complex jobs.
Sir Andrew Large was Deputy Governor of the Bank of England and a Member of its Monetary Policy Committee from September 2002 to January 2006. He is a Founding Partner of the Systemic Policy Partnership. Back