Central bank socialism: a primer

Peter Warburton - 7 August 2019

Many years ago, speaking at a conference organised by the Institute for Economic Affairs, I hit upon the phrase “killing us with kindness” to describe the actions of a central bank unwilling to take appropriate and justifiable, if unpopular, action in support of its legal mandate. As events unfold, this expression has increasing resonance. The demonisation of even the smallest interest rate rise or the most gradual tapering of central bank asset purchases is frequently accompanied by ad hominem attacks on the leaders and hawkish members of policy committees, fuelled by incessant simplistic messaging by the financial media.

The central banking establishment has adjusted to this hostile environment by adopting a convenient narrative that appears to justify permanently low interest rates on structural grounds. Speaking in Helsinki in early July, US Fed vice-chair Richard Clarida raised a flag for that elusive concept, r-star, the neutral (or natural) real interest rate. “This (alleged) global decline in r-star is widely expected to persist for years. The decline in neutral policy rates likely reflects several factors, including aging populations, changes in risk-taking behaviour and a slowdown in technology growth.” The repetition of this assertion was a clear signal that the Fed is preparing to hunker down on nominal interest rates, irrespective of incoming economic data.
Borrowers’ – think real estate developers’ – enthusiasm for the lowest possible interest rate is nothing new, but the revival of socialistic economics under the banner of MMT (Modern Monetary Theory) has re-introduced the radical notion that governments should not have to pay any interest on their borrowings. Wealth holders should be content to hold government bonds solely for their utility as a liquid (readily tradeable) asset. Ergo, governments should borrow freely in order to provide job guarantees, renew the infrastructure, protect the environment and keep everyone safe. That line item for debt service would be so much better deployed elsewhere.

Jim Grant has described the interest rate as “the price of impatience”.  If capitalism, in its most noble form, espouses the cause of the patient accumulation of capital, socialism, at its rugged core, is the embodiment of the cause of urgent and impatient redistribution. Senior central banking executives have always occupied an implicit role as the upholders of financial discipline, confident in the bipartisan backing of the legislature and incumbent administration. In the face of bullying and intimidation, central banks are quietly abdicating their responsibility to the Ground Zero socialists.           

Claudio Borio, of the BIS, and his colleagues provide compelling evidence that “monetary policy plays a significant role in anchoring the financial cycle” (see figure 1).  In a working paper entitled “What anchors for the natural rate of interest?”, published in March, the authors demonstrate that the reaction function of central banks influences the financial cycle, not least by influencing risk-taking. The cumulative impact of policy today may end up constraining policy choices tomorrow. 

“In practical terms, the issue is not so much whether monetary policy should lean against the wind; rather, monetary policy is the wind – for better or worse, the policy regime is a determinant of long-run outcomes (including r-star).” The endogeneity of monetary policy renders the quest to reflect a notional decline in r-star, in policy rates, a futile and perilous endeavour.  Central bankers are faced with a choice: the defence of capitalism (in the sense of flourishing capital markets and active price discovery) or capitulation to a planned economy and artificial prices.
Figure 1: 

Source: Bank for International Settlements Working Paper 777, March 2019

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