The Economist’s blogs: Democracy and central banking. Long to reign over us

STEPHEN King of HSBC has an interesting piece in today’s FT on how central banking is becoming politicised, suggesting that the era of independent central banking is coming to an end. There is a contrasting blog from Gavyn Davies also on the website.

It is worth remembering that this is not a new debate. The British Labour government nationalised the Bank of England after the Second World War, a step widely seen as an act of revenge for the „bankers’ ramp” that ousted its predecessor in 1931. Back then, the Bank, as the guardian of the currency and keeper of the gold reserves, demanded sharp cuts on public spending to please the markets; the Labour cabinet split and a Conservative-dominated coalition took over (it could never happen again!). The Bank didn’t get the chance to set interest rates again till 1997.

The Fed may have had nominal independence but in the 1970s, Arthur Burns was perceived to have fallen too much under the sway of the White House, allowing inflation to get out of control. It was down to Paul Volcker to create the idea of central banker as superman; his success in breaking inflation in the early 1980s inspired other nations (starting with New Zealand) to go down the independent central banking route. Of course, this was part of the intellectual shift that occurred in the 1970s when the use of Keynesian fiscal policy to fine tune the economy was perceived to have failed and the emphasis of economic management moved to monetary policy.

There are really two justifications for independent central banks. The first is that certain economic decisions can only be made by experts, and that politicians (and voters) lack the intelligence or training to reach the same decisions. We defer to the central banker as we defer to our doctor. The problem here is that there is no economic consensus (contrast Paul Krugman with John Cochrane, for example) and even the mainstream economic view changes over time (from classical to Keynesianism and back again).*

The second justification is that politicians cannot be trusted with the levers of monetary policy, for they will adjust interest rates to suit the electoral cycle or attempt to bribe voters with their own money. This is the central bankers as benign parent, stopping the kids from overdosing on ice cream and doughnuts.

The implication here is that central bankers will often be unpopular, particularly with elected politicians (Paul Volcker was perceived as ruining Jimmy Carter’s re-election chances).  However, as Gavyn Davies points out

none of the recent actions of the central banks, including the 2008 bank rescues and the subsequent credit easing, have been contrary to the wishes of elected officials, such as the US Treasury secretary, the UK chancellor, or a clear majority in Congress. As a result, there are very few signs that the political process sees any urgent need to re-assert any control over central bankers in these areas. Obviously, this could change if central bankers were to become more hawkish in ways that could prove politically unpopular, but to date there is little sign of that happening either.

Stephen King argues in contrast that central banks

can no longer be properly „independent” because their policies are creating both winners and losers. They are making decisions that are inherently political. Once politicians recognise this, they will surely be tempted to take over the reins.

Like Mr Davies, I am not sure that point will come soon: what government will complain that a central bank is buying its bonds and making it easier to finance its deficit? Holding down the yield curve may be the right macro-economic policy to follow but, in purely democratic terms, the Republicans surely have a point; a government that can persuade a central bank to finance its deficit has a huge advantage over the opposition.

In Europe, Mario Draghi was portrayed as the saviour of the markets in 2012 for his promise to do „whatever it takes” to save the euro. Here there is even more scope for democratic doubts; Mr Monti was using the balance sheet of the ECB, the bank of all euro-zone electors, to back the bonds of a limited portion of euro-zone electors. He was doing it with the tacit agreement of the German government but against the wishes of the Bundesbank, not that long ago seen as the font of all wisdom in German economic policy. (And this ECB/Bundesbank clash was another indication that there is no universally-agreed correct policy to which all central bankers adhere; indeed, Mr Draghi’s predecessor, Jean-Claude Trichet, seemed to take quite a different view.)

How do Germans vote if they want to get rid of Mr Draghi? Like it or not, they are stuck with him. In Britain, we will soon have a Canadian, Mark Carney, as one of the most important decision-makers in the British economy; someone not just unelected, but earning several times more than our prime minister. Mr Carney has hinted at switching away from inflation-targeting to nominal GDP targeting; an interesting concept when GDP gets revised up and down so often. Now perhaps we, as electors, are all too stupid to make these decisions. But if such vital economic matters aren’t the subject of democratic decision-making, what is?

sursa> The Economist

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