Having listened to the three witches, and acted accordingly, only to be betrayed ‘in depest consequence’, our hero ‘Macbeth’ reaches his ascendancy, which marks the start of his downfall. He has a moment of realisation…
Have central banks also reached an epiphany?
Central banks have been instructed to keep their eyes not only on inflation control but also on ‘financial stability’. They have been granted added responsibilities and instruments to achieve this. They have gathered nearly all the real tools of policy in their hands. Inevitably, they have also become closer to governments. George Osborne, UK chancellor of the exchequer, wrote to the governor of the Bank of England only a few weeks after the legislation giving effect to the reforms was passed, saying that ‘at this stage of the cycle’, it is ‘particularly important… that the committee takes into account, and gives due weight to, the impact of its actions on the near-term economic recovery’. This is typical of the new tone that finance ministers are adopting towards their central bankers – much more intrusive and assertive than they were pre-crisis.
Central banks’ ascendancy
Do the new responsibilities modify the focus on inflation control? Some central bankers think that monetary policy instruments – notably interest rates – should be reserved exclusively for maintaining price stability, and that other tools should be used to achieve financial stability. Others believe, however, that the full panoply of weapons, including interest rates, should be available if necessary to ‘lean against’ emerging bubbles in house prices or other assets. The arrangements introduced by the major financial centres differ in detail but they share certain characteristics. They also have a number of disquieting implications.
Implications….
The new regulatory set-up gives unelected central bankers/regulators considerable discretionary powers over the private sector. True, in some circumstances they will need political sanction to proceed with a measure they might wish to take, but they will be called on to take many detailed day-to-day decisions with life-changing implications for individuals and firms. Whether they can in practice be held properly accountable is questionable. This raises the dangers of the abuse of arbitrary power that Hayek warned about in The Road to Serfdom.
An assumption is that the new macro-prudential tools offer an alternative to use of interest rates – e.g. in handling asset bubbles (e.g. Gavyn Davies, FT.com, June 2, 2013: ‘QE is unlikely to be reversed soon. It will not cause inflation in the foreseeable future. Regulation and macro-prudential policy can handle any bubbles it creates’). But, in a country with developed financial markets and without capital controls, borrowers deprived of chances to borrow from one source will find others. This is why failure inexorably leads to more controls. That is why, contrary to popular assumptions, macro-prudential measures do not offer a genuine alternative to the use of the interest rate weapon. They can only work through their effect on interest rates, or, preferably, in conjunction with interest rates. It is being sold to politicians and the public on a false prospectus.
..and the great betrayal
There is a potential loss of control over prices. Major central banks now in effect follow multiple mandates – a largely undefinable objective of financial stability jointly with a fuzzy objective of growth-with-low-inflation. This implies there is no price rule.
The new arrangements give governments an ‘alibi’ – the freedom to blame central banks/regulators when a big bank or other financial group gets into trouble.
They also give commercial bankers a new alibi – ‘the regulators have made a hash of it again!’. Thus, expect banks to comply meticulously with the regulations while paying less attention to building their own defences. If a bank management has a choice between doing what is needed to put the bank on a sound footing and complying with regulations on pain of severe penalties, there are no prizes for guessing which they will choose.
The result? The system becomes more risky. Society soffers. Everything goes wrong.
The next instalment looks at the failure of banking reform, the international reserves timebomb and the search for a miracle.
The epiphany of central banking
Part 2 of a new series
Having listened to the three witches, and acted accordingly, only to be betrayed ‘in depest consequence’, our hero ‘Macbeth’ reaches his ascendancy, which marks the start of his downfall. He has a moment of realisation…
Have central banks also reached an epiphany?
Central banks have been instructed to keep their eyes not only on inflation control but also on ‘financial stability’. They have been granted added responsibilities and instruments to achieve this. They have gathered nearly all the real tools of policy in their hands. Inevitably, they have also become closer to governments. George Osborne, UK chancellor of the exchequer, wrote to the governor of the Bank of England only a few weeks after the legislation giving effect to the reforms was passed, saying that ‘at this stage of the cycle’, it is ‘particularly important… that the committee takes into account, and gives due weight to, the impact of its actions on the near-term economic recovery’. This is typical of the new tone that finance ministers are adopting towards their central bankers – much more intrusive and assertive than they were pre-crisis.
Central banks’ ascendancy
Do the new responsibilities modify the focus on inflation control? Some central bankers think that monetary policy instruments – notably interest rates – should be reserved exclusively for maintaining price stability, and that other tools should be used to achieve financial stability. Others believe, however, that the full panoply of weapons, including interest rates, should be available if necessary to ‘lean against’ emerging bubbles in house prices or other assets. The arrangements introduced by the major financial centres differ in detail but they share certain characteristics. They also have a number of disquieting implications.
Implications….
The new regulatory set-up gives unelected central bankers/regulators considerable discretionary powers over the private sector. True, in some circumstances they will need political sanction to proceed with a measure they might wish to take, but they will be called on to take many detailed day-to-day decisions with life-changing implications for individuals and firms. Whether they can in practice be held properly accountable is questionable. This raises the dangers of the abuse of arbitrary power that Hayek warned about in The Road to Serfdom.
An assumption is that the new macro-prudential tools offer an alternative to use of interest rates – e.g. in handling asset bubbles (e.g. Gavyn Davies, FT.com, June 2, 2013: ‘QE is unlikely to be reversed soon. It will not cause inflation in the foreseeable future. Regulation and macro-prudential policy can handle any bubbles it creates’). But, in a country with developed financial markets and without capital controls, borrowers deprived of chances to borrow from one source will find others. This is why failure inexorably leads to more controls. That is why, contrary to popular assumptions, macro-prudential measures do not offer a genuine alternative to the use of the interest rate weapon. They can only work through their effect on interest rates, or, preferably, in conjunction with interest rates. It is being sold to politicians and the public on a false prospectus.
..and the great betrayal
There is a potential loss of control over prices. Major central banks now in effect follow multiple mandates – a largely undefinable objective of financial stability jointly with a fuzzy objective of growth-with-low-inflation. This implies there is no price rule.
The new arrangements give governments an ‘alibi’ – the freedom to blame central banks/regulators when a big bank or other financial group gets into trouble.
They also give commercial bankers a new alibi – ‘the regulators have made a hash of it again!’. Thus, expect banks to comply meticulously with the regulations while paying less attention to building their own defences. If a bank management has a choice between doing what is needed to put the bank on a sound footing and complying with regulations on pain of severe penalties, there are no prizes for guessing which they will choose.
The result? The system becomes more risky. Society soffers. Everything goes wrong.
The next instalment looks at the failure of banking reform, the international reserves timebomb and the search for a miracle.
Written on June 17, 2013 at 9:57 am, by robert
Categories: Banking, Homepage, News and Comment, Official Money, RP's Diary | Tags: banking, central banking, central banks, financial crisis, George Osborne, robert pringle