Howard Davies points to an important problem facing the world – the power of central bankers. They have become way too powerful and important for not just their own good but everybody else’s as well:
Central banks have been on a roller-coaster ride in the last decade, from heroes to zeroes and back again. Is another downswing in their fortunes and reputations now starting?
In 2006, when Alan Greenspan retired after his 18-year reign as Chair of the US Federal Reserve Board, his reputation could hardly have been higher. He had steered the US economy through the dot-com boom and bust, had carefully navigated the potential threat to growth from the terror attacks of September 11, 2001, and presided over a period of rapid GDP and productivity growth. At his final Board meeting, Timothy Geithner, then-President of the New York Fed, delivered what now seems an embarrassing encomium, saying that Greenspan’s stellar reputation was likely to grow, rather than diminish, in the future.
Only three years later, the Nobel laureate economist Paul Krugman, borrowing from Monty Python’s parrot sketch, was able to say that Greenspan was an ex-maestro whose reputation was now pushing up daisies. Central banks were widely seen to have been dozing at the switch through the early years of this century. They allowed global imbalances to build up, looked benignly on a massive credit bubble, ignored flashing danger signs in the mortgage market, and uncritically admired the innovative but toxic products devised by overpaid investment bankers.
The early reactions by central banks to the deepening crisis were also unsure. The Bank of England (BoE) lectured on moral hazard while the banking system imploded around it, and the European Central Bank continued to slay imaginary inflation dragons when almost all economists saw far greater risks in a eurozone meltdown and associated credit crunch.
Yet, despite these missteps, when governments around the world considered how best to respond to the lessons of the crisis, central banks, once seen as part of the problem, came to be viewed as an essential part of the solution. They were given new powers to regulate the financial system, and encouraged to adopt new and highly interventionist policies in an attempt to stave off depression and deflation.
We know what happened from hereon. Balance sheets have expanded and all kinds of crazy things have happened. On top of that independence has come to mean challenging governments on all possible fronts but ensure govt has no right to say anything on monetary policy.
That points to the biggest concern of all. Central banks’ monetary-policy independence was a hard-won prize. It has brought great benefits to our economies. But an institution buying bonds with public money, deciding on the availability of mortgage finance, and winding down banks at great cost to their shareholders demands a different form of political accountability.
The danger is that hasty post-crisis decisions to load additional functions onto central banks may have unforeseen and unwelcome consequences. In particular, greater political oversight of these functions could affect monetary policy as well. For this reason, whatever new mechanisms of accountability are put in place will have to be designed with extraordinary care.
These are institutional concerns. What is also a concern is some central bankers achieving demigod status with markets. They have this cult following from paying a pied piper to markets. All this all fades away as smoke over their aura is eventually lifted and results into a shock.
Hope India too learns some lessons from what is happening around the central banking world. We could be in for a similar rude shock as well..