November 8, 2018 / 2:34 PM / 9 days ago

Hadas: Central bankers stuck between two myths

LONDON (Reuters Breakingviews) - Politicians are once again trying to push central banks around. Donald Trump and his counterparts in India, Turkey, Russia and South Africa are complaining that the monetary authorities are resisting the popular will. The pressure is quite justified, and also totally wrongheaded.

G20 finance ministers and central banks governorsat the IMF-World Bank spring meeting in Washington, U.S., April 20, 2018. REUTERS/Yuri Gripas

Mostly, elected leaders like Trump want their central banks to keep interest rates low and not worry too much about lax lending standards. Sometimes, though, the issues are more complicated. In 2016 Prime Minister Narendra Modi’s government mandated a redenomination of the currency over the profound reservations of the Reserve Bank of India. In the euro zone, the European Central Bank’s critics bash its bond-buying programme for granting hidden subsidies to the single currency’s fiscally weak members. 

The tension can hide a basic consensus. Only a few dictators in countries like Zimbabwe and Venezuela have pursued monetary ruin for the sake of having money to pay off supporters and potential enemies. Almost everywhere else, politicians and central bankers alike want low inflation rates, stable economic growth and a non-toxic financial system.

Still, there is a serious argument over who decides how best to reach those goals. How much freedom should central banks have to determine their own policies? The debate is confused by two myths. On one side, central bankers are tempted to believe that monetary technocracy is a realistic possibility. On the other, some politicians indulge in magical thinking about their own interventions.

Start with the conventional defence of central bank independence. Though the 2008 global financial crisis dampened the ardour for this cause, many experts still think monetary policy and financial regulation are essentially no more political than, say, road safety.

These purists claim that in normal times central bankers can live up to the modest ideal which John Maynard Keynes set for economists: exercising a technical skill, like dentists. Politicians should provide central banks with general goals and broad standards. The technocrats will take care of the rest.

Yet even the truest believers in independent central banks admit that the work can become political in exceptional circumstances. The emergency measures that were rushed in across the developed world in 2008 and 2009, followed by a decade of ultra-stimulative monetary policy, might qualify as a very large and long exception. Still, believers argue that even such gigantic exceptions do not discredit the basic rule of political neutrality, no more than the removal of civil rights in wartime means that democracies are hidden dictatorships.

That picture is faulty. Politics is built into central banking. Interest rates have a big influence on the division of income between generally privileged lenders and usually poorer borrowers. Decisions about bank regulation can help different socioeconomic groups and industries. Monetary policy choices may not be as politically divisive as war or welfare programmes, but they are too controversial ever to be purely technocratic.

Consider the political consequences of the post-crisis choice by central banks to inject money into economies through the purchase of financial assets with newly created funds. Quantitative easing increased the prices of these assets, adding to the net worth of their mostly already affluent holders. A different policy choice – such as, say, crediting individual bank accounts with new funds – would have had a quite different effect on the distribution of spending power and wealth.

Politicians can legitimately demand a larger say in these essentially political matters. However, they should be careful what they ask for. While central bankers have often been blindsided by events, there is no reason to think that politicians can do better.

Indeed, the politicians who actually want to muck into monetary policy are mostly chasing their own illusion. They claim that additional short-term monetary stimulus will be effective and safe. They may be right in the short term. Easy money can sometimes keep growth up for a quarter or two, or even stave off a banking crisis until after an election. However, in the long term, too-low interest rates and too much lending only worsen existing economic and financial problems. Politicians lack the credibility to resist these short-term temptations.

Clashes between excessively defensive central bankers and foolishly aggressive politicians are regrettable, because they would be better off working together. For example, only strong political backing can break the curse of financial excess, which lies behind most economic downturns these days. Closer coordination of monetary and fiscal policy is also sensible.

Helpful cooperation would be natural in a world without either political opportunists or arrogant central bankers. In such a world, there would be no need to promote the myth of central bank independence.

Reality is quite distant from this ideal. When Trump and his fellow leaders complain about recalcitrant central bankers, their pressure is far more likely to do harm than good. Under such unfortunate circumstances, the pretence of central bank independence is worth defending. The uncomfortable status quo is probably the last bad alternative.

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