OWho would like to be responsible for monetary policy in 2022? Judging by the fierce economic and political debates taking place around the world, it is as if the hunt for central bank governors is open: they are criticized from all sides.
US Federal Reserve Chairman Jerome Powell and his colleagues are blamed for failing to detect early signs of an inflationary threat last year. As recently as last fall, they claimed the price increases were “transitional”. With US annual inflation now approaching double digits, this seems to have been bad judgment. But now that the Fed has admitted its mistake and is raising interest rates, many blame it for stifling post-pandemic recovery, crashing stock and bond markets and precipitating a recession.
The European Central Bank has yet to start raising rates, although it is expected to do so in July. The ECB is accused of indecisiveness and of sowing the seeds of a new eurozone crisis by suggesting a potential reversal of quantitative easing. The spread between Italian and German government bond yields has widened significantly, threatening fiscal stability in southern Europe. An anti-fragmentation weapon has been promised but remains on the drawing board for now.
The Bank of England faces a roadmap similar to that drawn up against the Fed, with some additional wrinkles. Some have accused Bank Governor Andrew Bailey of washing his hands of the inflation problem by blaming exogenous factors – the war in Ukraine and energy shortages – for the rise in prices. The Bank is also accused of “groupthink”. Three of the four outside members of its monetary policy committee voted twice for higher rates, only to be opposed by the Bank’s five insiders.
The Bank of Japan is in a different position. He is accused of doing nothing and presiding over a sharp drop in the external value of the yen.
It is tempting to conclude that today’s central bankers are damned if they do and damned if they don’t. Maybe if they stay seated, they’ll ride out the storm. Then-Fed Chairman Paul Volcker was America’s public enemy number one in the early 1980s when he knocked post-oil shock inflation out of the system with interest rates two digits. But in his later years he was revered and became a national treasure, called upon to advise successive presidents in times of financial emergency.
But central bankers would be wise not to assume that their reputations will automatically recover and the status quo ante will be restored. We live in more contested times than the 1980s. Public institutions are more regularly challenged and held to account by far less reverent legislators.
When another former Fed Chairman, Alan Greenspan, told Congress that he “learned to mumble with great inconsistency,” it was taken as a witty aside. Such a remark would not sit so well today. The pride of being obscure is no longer fashionable. After a long period when openly criticizing an independent central bank was not done, politicians today often do so eagerly. The Fed and the ECB are strongly criticized in Congress and the European Parliament respectively. One of British Prime Minister Boris Johnson’s closest political allies has called on Bailey’s head at the Bank of England.
Moreover, former central bankers have joined the chorus of critics. Former Fed Chairman Ben Bernanke, breaking the unwritten rule not to blame his successors, said today’s Fed made “a mistake” by reacting slowly to inflation. And Bailey’s immediate predecessors, Mervyn King and Mark Carney, have also weighed in on challenges to Bank policy. The fabric of central banking fraternity is unraveling.
Will this disapproval gain strength? Could it blend into a coherent critique, perhaps leading to rethinking central bank independence and inflation targeting?
Although central banks hardly performed impressively on the eve of the 2008 global financial crisis, they were, paradoxically, the biggest winners from its aftermath. Despite the failings of monetary policymakers, governments around the world have entrusted them with new powers and responsibilities, particularly in the regulatory arena. They come out stronger than ever.
But now there are ominous signs of a backlash, including in two new books that challenge the political orthodoxy of past decades. Two swallows don’t make a summer, but they make you wonder if the weather is about to change.
In The Price of Time, Edward Chancellor mounts a frontal assault on the policies adopted by central banks over the past 15 years. According to him, by focusing only on consumer price inflation and neglecting asset prices, central bankers have hurt investment and growth, created financial instability with very low interest rates and increased inequality through QE. The paradigm, according to the Chancellor, needs to be seriously reworked. Monetary authorities need different objectives and increased accountability.
Jon Danielsson, professor of finance at the London School of Economics, is more concerned about excessive concentration of power. In The Illusion of Control, he argues that placing central banks in charge of financial stability is a mistake because they face “a complex and ill-defined policy domain for which there is no clear consensus on the problem or the goal”. The company is therefore doomed to failure. Separate bodies, with more direct political responsibility, are needed for this task.
These criticisms may be overstated. But they raise important questions that central banks need to answer. Mumbling with great incoherence won’t put those challenges to bed. Monetary policymakers will need to muster their defenses more effectively and should not assume that central bank independence is the end of monetary history.
Sir Howard Davies, the first chairman of the UK’s Financial Services Authority, is the chairman of the NatWest group. He was Director of the LSE and was Deputy Governor of the Bank of England and Chief Executive of the CBI.
© Syndicate Project