Central bank independence: use it or lose it

Peter Warburton - 25 October 2017

Former Fed chief Paul Volcker is said to have quipped at a Washington party that “central bankers are brought up pulling legs off ants.” A more reliable quote is from William McChesney Martin, who opined that the job of the Fed was take away the punchbowl just as the party was getting going. Both aphorisms portray central bankers as dispassionate clinicians, acting according to well-established practices to pursue agreed objectives without fear or favour.

Bad things happen when interest rates rise: decisions are deferred; plans abandoned; payments are missed; property repossessed; staff lose overtime (if anyone can remember what that is) or are even made redundant. However, good things happen as well: rising interest rates are an expression of capital discipline. Individuals and businesses work harder to pay down their debit balances and this releases lending capacity to other individuals and businesses. A by-product of very low interest rates is the so-called zombie phenomenon, whereby loans are barely serviced and never repaid. The recycling of credit to new enterprises and activities is curtailed.

The 1980s central bankers were like bus drivers. They were given a route and a schedule and expected to get on with it. If any of the passengers suffered from travel sickness or slipped on the stairs, then it was their personal responsibility. There was no basis of a claim against the bus company, much less the bus driver. This settled understanding of the role of central banks has been overturned by the global debt binge and ensuing financial crisis. Instead of bus drivers, central bankers have become ambulance drivers. They have been given permission to break the traffic rules, at will, but woe betide them if anyone gets hurt. The customers are to be wrapped in cotton wool.

The problem with this softer, gentler central banking is that it doesn’t work and it cannot work. Central banks are killing us with (misplaced) kindness. Every day that passes, with near-zero short-term interest rates and undiminished balance sheet largesse, the functional independence of central banks erodes. The encroaching host, comprising do-gooders, bleeding hearts, industrial bullies, financial wizards and politicos, has so harried the central bankers that they are virtually paralysed. Gamed by the asset management industry, fingered by the inequality lobby and leant on by powerful politicians, central bankers have allowed themselves to be painted into a corner.

Like the Last Man In, as they keep playing and missing, the fielding circle closes in for the easy catch. Time is running out for modern central banking. Unless the incumbents start to take their independence seriously, it will be snatched from them in the twinkling of an eye. Not even the next financial crisis will save them. Ants and party animals, take note!

Source: BIS

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