Today, Central bankers have power over one of the most important economic policy spheres in a modern-day economy – i.e. monetary policy (usually in the form of interest rates).
However, this was not always the case. During the 1980s this power was transferred to Central Bankers in the guise of inflation-fighting. This transfer of power was due to the apparent inability, irresponsibility, and/or untrustworthiness of governments to take the necessary steps to control inflation.
To placate those concerned at the time at the apparent loss of democratic control over a core area of policy, there was reassurance from the ‘rules versus discretion’ literature. That is, there was no handover of policy power, just the handover of the implementation of a fixed ‘rule’ (i.e. loosen monetary policy if inflation is low; tighten monetary policy if inflation is high). Indeed, this was an acclaimed virtue of the move.
The simplicity of a ‘single target, single tool’ framework, meant the implementation of monetary policy could be transferred to a team of technocrats (i.e. Central Bank officials). Moreover, such technocrats would be immune to pesky external influences. Consequently, if any discretion was to be exercised then that would only be at the behest of Government. So, there was no loss of democratic accountability, choice or control.
The power grab
But, some three decades later, this argument is negated through the Central Bankers own admissions. An example is the recent speech by the Governor of the Reserve Bank of New Zealand -
Monetary policy decisions are influenced by assessments of such questions based on research, modelling and scenario analysis. The complexity of the discussions that underlie policy decisions within a central bank belies the apparent simplicity of what is often a single interest rate instrument and a single inflation target.
In the end, judgement is inevitably involved in balancing a range of risks and uncertainties. Some of these lie beyond the influence of the central bank, while others can be addressed or moderated through monetary policy. Policy decisions inevitably involve reflection and pragmatism in managing different trade-offs.
And there you have it. The Central Bank does not impose a ‘rule’. Rather, it exercises judgement. And that admission, to me, is more than a bit breath-taking.
Judgement decisions on what economic policy should, or should not, be implemented lies rightly in the hands of the elected government. Government is the institution that is accountable to the people. Government is the only institution that has the mandate to make judgements as to which policy should, or should not, be implemented.
This distinction is not academic. It is critically important because judgement decisions are about trade-offs, as is clearly articulated in the Governor’s speech. And trade-offs inevitably result in some winners and some losers. That is the very nature of a trade-off.
I would argue strongly – nay, vehemently – that policy trade-off decisions should be clearly in the hands of our elected representatives. I want them to justify their decided choice of winners and losers, and have the opportunity to dismiss them if I disagree with their choices. That is the very nature of democracy.
Call me naïve if you must; but I do not remember handing over my right to influence the division of society between winners and losers to a group of technocrats. Definitely not to a group of bankers.
Bluntly, policy trade-off decisions should not be in the hands of technocrats, unelected officials, or – least of all – in the hands of a group of bankers
How did we get here?
Effectively, over the last three decades there has been considerable mission creep for the monetary policy framework. We started with an agreed target based on a ‘rule’, which limited discretion. But the original agreement to contract-out the implementation of monetary policy to a group of technocrats has been unilaterally re-written.
In essence, Central Banks have consolidated and expanded their powers so that they now include discretionary decisions as a ‘natural’ component of their function. There is now an entrenched acceptance that Central Bank power is the norm in the management of any economy.
Further, many governments around the world have been keen to accommodate this breach of contract in order to fulfil their desire to limit government discretionary intervention; while other governments have just remained either blind and culpably neglectful to this consolidation of power.
What needs to happen?
There needs to be a brake, and then a reversal, on the expansion of power and influence of Central Banks. They need to be reminded of their subservient status. Central Banks serve the economy; not the other way around. Central Banks should not be seen as ‘all powerful’. Rather, their role of implementing the policy decisions of Government needs to be re-established.
However, this also needs Government to step up to its role and responsibilities. Central Banks are not responsible for managing an economy; they are not responsible for ensuring sufficient housing supply to provide shelter for the populace; they are not responsible for ensuring wage levels are sufficient to live on; nor are they responsible for avoiding the next economic recession.
These are all the role and responsibility of Government. Government just need to stop contracting out their policy-setting role and to stop neglecting their responsibilities.
*Dr. Ganesh Nana is the Chief Economist and the Executive Director at BERL. You can contact him here (email) or here (Twitter). This article was first published here and is reposted with permission.
36 Comments
Interesting - I'm neither a banker nor an economist so from a professional perspective i cannot speak, however as a member of the public I would have said largely ineffective and therefore irrelevant.
My major concern is the lack of regulation around banks, that my money is theirs legally if i deposit with them, that they hold all the power in this relationship, that the regulations don't appear to put much onus on them to protect my money, after all i'm just an unsecured creditor!
The problem I see is CBs are being left to do the heavy lifting while Governments sit there and do diddly. I am not sure why this is the case but it seems to be "lets stick our head in the sand and hope the problem goes away" and/or "lets leave it to the CB, if it blows we can blame them" sort of governance.
Exactly Mr. Nana - bravo.
Once the people’s mindset changes, what they will find in especially Federal Reserve conduct could border on criminal neglect. There was Greenspan’s warning in June 2003 that perhaps the banking world had indeed changed in a meaningful way, and that monetary capabilities might need to be more carefully examined before they had to be used as in the Japanese experience. Three years before that, Alan Greenspan admitted right in the FOMC transcripts that the Fed had no idea what modern money even was:
The problem is that we cannot extract from our statistical database what is true money conceptually, either in the transactions mode or the store-of-value mode. One of the reasons, obviously, is that the proliferation of products has been so extraordinary that the true underlying mix of money in our money and near money data is continuously changing. As a consequence, while of necessity it must be the case at the end of the day that inflation has to be a monetary phenomenon, a decision to base policy on measures of money presupposes that we can locate money. And that has become an increasingly dubious proposition.
Did the Fed expend every resource to rectify this knowledge gap? No; emphatically no. Quite the opposite as they openly proved in discontinuing M3 in March 2006, writing in the official press release that the “costs of collecting the underlying data and publishing M3 outweigh the benefits.” Any institution that made such judgment only a little over a year before the repo and eurodollar markets blew up should be prohibited from all discussions going forward. Read more
Perhaps blockchain will provide a solution? http://www.ted.com/talks/don_tapscott_how_the_blockchain_is_changing_mo…
The market is all the people/participants..........so what if markets go up and down that is how people learn as things transfer around.........an over protected economy will behave in the same manner as an over protected child.......no one benefits and worst of all the child like the economy is limited......now that is clueless, short-term and self-serving isn't it???
Monetary policy in Sweden has failed for almost half a decade to drive inflation back to target. The bank this year extended its QE program, targeting about 37 percent of nominal government debt by the end of 2016 and about 9 percent of inflation-linked state paper.
According to Olofsson, one sign that liquidity has deteriorated since the Riksbank started buying bonds two years ago is the decline in volumes for given spreads. There has also been an increase in the number of re-sellers over the summer that have had to ask the debt office for help to deliver government bonds to investors through repo transactions. Read more
It is hard do disagree with Mr Nana. The single target, single tool mantra has fairly clearly failed, not just in NZ, but globally. And so I would certainly advocate a broader range of objectives, and more importantly, a broader combined fiscal and monetary use of various tools to achieve some core objectives, including asset, price and wage inflation, employment, total debt- government and private, the current account, infrastructure and so on.
While I would have my own priorities for these, I agree with Mr Nana that they should be prioritised by the elected government, and not by technocrats. Perhaps at most some independent brake on runaway inflation would be ideal, and that could be structured easily enough into a Reserve Bank mandate.
Nice one Ganesh. Handing over power to a bunch of overpaid and overpromoted civil servants seemed like a good thing at the time. For a while it worked, but that time is past. What we now need is irresponsible politicians. They will easily find a way to overspend or undertax and create as much inflation as we want, and more besides.
I can't stand the idea of Government getting control of the printing presses, but what we have now is hardly independent
Is there a way , that may work , where policy is set by a 'super majority' of parliament , say 81 of 121? Does it exist anywhere in the world ?
Yes MMP has a lot to answer for. Another idea that seemed a good one at the time. Now we have "List MPs" who are even more out of touch, and a disfunctional government where stagnation is pretty much guaranteed. Lets try a few more referenda, the last one told them where to go.
Roger,
I agree that there are real issues with MMP as it currently exists,but I would not wish to go back to First Past the Post. I spent most of my voting life in a constituency in Scotland where it was absolutely certain that the Labour candidate would be elected,so a vote for any other party was useless.
As we have become such an open economy our reserve bank has become limited at controlling inflation. World commodity prices have dropped so low and are the reason for our lower inflation. In particular oil which is nearly a third of what it was. We are a price taker. If oil climbs again to $120 a barrel again our inflation rate will go up again. As weve seen the world over historic low interest rates have not been enough to stimulate western economies out of stagnation and will be interesting to see how long this continues. Maybe its just a symptom of a worlds finite resources being distributed more against a rapidly growing world population.
Also the latest news is that banks have not passed on the 25 basis points cut the RB implemented. So if this is the case again with another cut it decreases the effectiveness of monetary policy.
It seems to me to have a reserve bank with very limited tools why have one at all. If the only purpose is to raise and lower interest rates as a result of world commodity prices let the finance minister do it or simply let banks moderate their risk themselves. Have a policy where if they fail they fail. No bail outs. Simple.
I agree, elected governments' economic policies have quietly been dismantled or outsourced to the Reserve Bank. Not that long ago commentators would question 'how will interest rate changes influence economic activity and unemployment?. Now it's been switched around. Economic commentators ask what will unemployment, wage growth and spending etc do to interest rate decisions.
What the government allows the RB to manage at its discretion usually relates to areas they would rather not have to deal with. However, when the RB offers opinions such as the impacts of immigration policy on society it is quickly brushed aside, much like Treasury is when they make sound, common sense recommendations.
Thank goodness someone is speaking out. The real question is why did government, and it was a Labour Government. give up its power over the economy to an unelected individual. After all politics is economics - nothing more nothing less. A government should have to explain how and what it wants to do with our money. The people and the journalist then should have the right to question a government as to those decisions but those rights were abrogated in 1989 by the Reserve Bank Act.
Patricia,
Government handed over interest rate policy to the RB in 1990 because of persistent high, long-term inflation. Over the preceeding 2 decades, CPI inflation had averaged over 11%pa. After the RB was given the task of inflation targeting, it fell very sharply and over the next 2 decades,averaged around 2.50%pa.
Until recently,many countries have found this approach useful,though right now, it is proving not be particularly useful. Politicians want above all to be re-elected and if given back the power to set short-term interest rates, will be unable to resist manipulating them for short-term political gain.
I am no fan of Graeme Wheeler and in a world where negative rates are in danger of becoming entrenched,a policy of targeting inflation through the OCR is clearly not working,but whatever changes are needed, simply handing policy back to the politicians is very unlikely to be the answer.
Excellent piece; good writing!
However, the biggest power of the RB is printing money, not issuing policy!
Why should a bunch of banksters decide when and how much of our money to print?
Both, the power to issue currency, and the power to issue policy should lay in the hands of the people, not the government! It was the government who gave the power away in the first place. Why give it back to them?
How did Central Bankers get to be so powerful?
Good question. Not because of accomplished knowledgeable practice.
Yellen:
As noted above, her speech was throughout preoccupied with the very real possibility that interest rates might not ever recover. That is a marked difference from not all that long ago when “transitory” was still the operative theory. In trying to explain how and why that might be, Yellen mostly defers, bringing up factors like weak productivity, structurally lower inflation (so much for “transitory”), demographics, the low natural rate of interest, and even a possible “decreased propensity to spend in the wake of financial crises around the world” as if that didn’t suggest anything about the job central bankers in general have been doing. In other words, she is left to just throw a number of things against the wall because she really doesn’t know and even says so:
Although these factors may help explain why bond yields have fallen to such low levels here and abroad, our understanding of the forces driving long-run trends in interest rates is nevertheless limited, and thus all predictions in this area are highly uncertain.
It is quite far from the interest rate fallacy or admitting the bond market riddle isn’t actually a riddle, but coming from where economists have been it is perhaps much closer than anything we have seen in years, if ever. Read more
Hmmm. I have been highly critical of our RB for some time and it is abundantly clear that the government is using the Bank as an excuse for doing so little on the housing crisis. BUT, do we really want to throw the baby out with the bath water? Those with sufficiently long memories will recall the days of double-digit inflation and the use of interest rates by politicians for largely/purely political ends.
I certainly don't want to go back there,so I think we need to tread very carefully before we alter the RB's remit,though I would have no objection to changing the Governor.
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