December 2016: Power of personality

Central banks are under fire, not for the traditional reason of high interest rates, but because of low ones. After the expected US rate rise in mid-December – only the second formal Federal Reserve credit tightening in 10 years – the heat is not likely to die down. OMFIF’s November edition was dedicated to an international shift to tighter monetary and looser fiscal policy. The December Bulletin focuses on another tide that is turning: greater constraints on central banking independence. Central banks are guided not just by statute and practice, but by the power of personality. As David Marsh notes, governments have an unusual opportunity to stamp their mark on monetary decision-making. In the next three years, governors of the top six worldwide central banks – the Fed, People’s Bank of China, Bank of Japan, European Central Bank, Bank of England and Germany’s Bundesbank – will reach the end of their terms and may be replaced by new faces. In the US, criticism of Janet Yellen, the Fed chair, by President-elect Donald Trump has generated headlines even before he moves into the White House. The auguries for transatlantic monetary relations are poor. In circumstances bearing some resemblance to today, US monetary policies after the election of two past Republican presidents – Richard Nixon in 1968 and Ronald Reagan in 1980 – led to squalls (the first when the dollar was weak, the second when it was strong) with significant international political impact. Possible tensions between two female heads of government in Europe – Angela Merkel in Germany and Theresa May in the UK – and their respective central bank governors, Mario Draghi and Mark Carney, are points of vulnerability in the months ahead.

We devote the monthly Focus to a review of the past 12 months, measuring the OMFIF advisory board’s 2016 New Year predictions against the course of events. The forecasts in the January 2016 edition highlighted political risk. Overall, OMFIF comfortably beat the consensus. We forecast that Hillary Clinton might not make it to the White House (we predicted Trump’s popularity but not his victory); the Fed funds rate would not rise above 1%; the UK would vote narrowly to leave the European Union; and the oil price would recover to $45 to $50 a barrel by end-2016. Furthermore we foresaw the renminbi would fall against the dollar; Angela Merkel would resist her political adversaries; emerging market currencies would recover; the US and Russia would achieve no rapprochement over Syria; and South African President Jacob Zuma would narrowly hang on. We were on less sure ground in predicting yen weakness, a fall in overvalued equity prices and another euro crisis – but all these topics remain on the agenda for 2017. On the travails of central banks, Andrew Large, former deputy governor of the Bank of England, investigates the problem of enlarged mandates, while Mojmir Hampl, deputy governor of the Czech National Bank, stresses the importance of communication. Øystein Olsen, governor of Norges Bank, explains the complications from lack of support in other policy areas. Focus on weakening the exchange rate raises the risk of currency wars, warns Linda Yueh. Carlo Cottarelli addresses the danger of negative returns for savers through ‘accidental financial repression’. Peter Warburton highlights the risk of accidental tightening through QE’s liquidity effects. DeLisle Worrell, governor of the Central Bank of Barbados, writes that the benefits of dollarisation outweigh the costs for small open economies. Meghnad Desai reflects on India’s demonetisation experiment. December’s 40th anniversary of the UK’s 1976 sterling crisis, marked by the OMFIF Press with Richard Roberts’ When Britain Went Bust, represents a watershed not just in the balance between Keynesian and monetarist policies, but also for central bank independence. As William Keegan writes in his review of the book (being launched on 8 December at the UK Treasury, with Johannes Witteveen, former IMF managing director), ‘The book could hardly have appeared at a more appropriate moment.’

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