Central bankers and journalists will meet for the Jackson Hole virtual conference later this week. Their agenda will be wide. The future path of quantitative easing (QE), the health of the labor market and other critical monetary and regulatory issues will take center stage. But we can also expect statements on issues once considered the domain of elected politicians, including climate change, racial justice and inequality.
The central bank’s comments on political matters deviate considerably from the practice of just a generation ago. Central bankers who lived through the high and volatile inflation of the 1970s saw independence as essential to the ability of central banks to maintain economic stability. And this autonomy went hand in hand with clear objectives and mandates, such as inflation targets.
The global financial crisis and its aftermath have significantly expanded the role of central banks. Large-scale asset purchases, or QE, went beyond money creation and extended to the allocation of credit through the purchase of non-federal government instruments and private bonds such as government bonds. companies. And the scale of money creation has created political interest in its continuation. The stock of assets purchased under QE now stands at 30% of gross domestic product in the US and 40% in the UK.
Amid widespread frustration with the inability of elected policymakers to address the critical issues of the day, influential voices have increasingly called on central banks to intervene. Central banks have become “the only game in town”. Central bankers responded readily, moving into the political arena. This started notably with climate change and the formation of the Network for Greening the Financial System (NGFS). But it didn’t stop there. , from education to public health. These are serious challenges for societies. But the seriousness of a problem is not the only, or even the most important, criterion for central bank involvement. Some problems deserve a monetary response. Most don’t.
It is true that many of these new issues have economic implications. Pollution, climate change and the decline of biodiversity affect the economy. But attempts to bring these issues into the realm of monetary policy place too much strain on central banks. In a world of radical uncertainty, their economists find it difficult to meet even their usual economic forecasting responsibilities. Recent inflation overruns, after a decade of persistent undervaluations, suggest the need for greater humility. Particularly strange is the growing attention of central banks to climate change. As the pandemic has shown, the financial system faces a range of extreme risks, from cyber attacks to political instability around the world. But central banks have little expertise in any of these areas. A recent Bank of England article noted, for example, the lack of any objective measure to “tilt” its purchase of corporate bonds to influence companies’ efforts to reduce their carbon emissions.
Regulators can better manage financial risk with strong capital and liquidity regulation, and an emphasis on operational resilience. And central banks’ most effective tool to protect people with low income and few financial assets is already built into existing monetary practice: namely, ensuring low and stable inflation so that living standards are not lower. eroded.
The new and broader ambitions of central banks have profound implications for their independence. Consider recent calls in the United States to target the unemployment rate of particular groups and regions. The mere appearance of joining in debates on public health measures or state aid to the unemployed makes it more difficult to maintain the independence necessary for the effective conduct of monetary policy. Already, central banks appear to be listening to the preferences of elected leaders even without real changes in their terms of office. Was it a coincidence that in the weeks following the election of President Joe Biden, the Fed joined the NGFS?
Such offers are unlikely to satisfy partisan political actors. Once politicians see central banks bending under the pressure, they will push harder. The concessions will then stimulate demands for more and central banks will be forced to go beyond managing the money supply and supervising the financial system. Wider central bank mandates, like the recently amended Bank of England mandate and the European Central Bank’s commitment to play a role in tackling climate change, could become more prevalent. And, as politics weigh more heavily in their calculations, central banks will have a harder time doing what they are uniquely qualified to do: ensuring financial stability. Economies are more likely to prosper when central banks are free to act independently, guided by sound economic judgment and not by short-term political convenience.
Mervyn King and Dan Katz are respectively the former Governor of the Bank of England; and former senior adviser to the US Treasury Department.
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