Wednesday, January 23, 2013

Is independent central banking over?

More posting on central banking. A number of articles in FT in recent days have written about the dramatic shift in the role of central banks, including one obituary of independent central banking.

The most decisive signal of the shift in central banks role and erosion of their autonomy has come from Japan. The new Prime Minister Shinzo Abe has come to power on a platform of promising to do whatever it takes to end the country's "lost decades". In particular, he has targeted the Bank of Japan (BoJ) as not having done enough to exit the deflationary trap and reflate the economy. In fact, he has openly demanded that BoJ raise its nominal inflation target to 2%, failing which he will enact a legislation to incorporate it into the bank's mandate. He has also called for more aggressive intervention to stem the appreciation of Yen against the dollar.

Truth to tell, the BoJ has been far more conservative than its counterparts in Europe and US. Despite the even more painful and protracted nature of the country's economic slump, the BoJ has for long refrained from anything remotely similar to what the Fed has ventured out. With debt-to-GDP ratio of more than 200%, the government has limited fiscal room, thereby making central bank's role critical in any meaningful and large enough attempt to prime recovery. This has given the politicians a rightful cause to demand more aggressive actions by the central bank. Shinzo Abe has only ratcheted it up in a manner that clearly threatens the BoJ's autonomy. And there is a clear danger that he may actually end up going too far with monetary expansion.

In simple terms, Masaaki Shirakawa has failed to display the political nous that is necessary to manage monetary policy, especially when the economic circumstances are extraordinary. In contrast, as Peter Tasker wrote, his compatriots Bernanke, Draghi, and Mervyn King, have factored in the political and social context while managing their monetary policy, thereby pre-empting any political assault on their domain. However, on the flip-side, such pre-emptive action may have had the effect of taking the pressure off governments to act immediately and aggressively, besides pushing monetary policy down a dangerous path and also taking .

Another reason for the erosion of independence of central banks is that their recent actions of extended extraordinary monetary accommodation has strong political overtones. Of greatest concern is its distributional implications. Stephen King points to a recent report (pdf here) by the Bank of England which talks about the inter-generational distributional implications of QE,
by increasing the net present value of pension funds’ future liabilities, it creates problems for those funds already running deficits. That, in turn, means either bigger pension contributions for workers; lower prospective pension benefits; or, in the case of some public sector pensions, tax increases or spending cuts to make the numbers add up. Meanwhile, some of the biggest beneficiaries of QE are those already asset-rich and relatively old who prefer to sit on their windfall gains rather than spend them.
Apart from this, there is also the issue of ultra-low interest rates punishing ordinary people who keep a major share of their savings in fixed income securities, whereas it has boosted the incomes of the richest who use leverage to make massive profits by investing in equities and other asset categories. These are ultimately political decisions and central banks cannot wish them away and go about their work as though they have nothing to do with these consequences.


Paul said...

I think you might like this article by Ambrose Evans-Pritchard: "Central bankers should be brought to heel by elected parliaments"

gulzar said...

Thanks Paul