The politicisation (or not) of central banks

Ótimo artigo sobre o papel do Banco Central no novo cenário econômico dos paises desenvolvidos que, curiosamente, não é muito diferente do debate no grande bananão.

The macroeconomic debate is now buzzing about “political dominance” over the central banks, under which elected politicians force central bankers to take actions they would not choose to take, if left to their own devices [1]. This is clearly what is happening in Japan, where the incoming Shinzo Abe government is not only imposing a new inflation target on the Bank of Japan (which is legitimate), but is changing the leadership of the central bank to ensure that the BoJ adopts policies compliant with the fiscal regime. This is not just political dominance, it is fiscal dominance, where monetary policy is subordinated to the decisions of those who set budgetary policy.

There have also been some early signs of political or fiscal dominance emerging elsewhere, notably in the use of the ECB balance sheet to finance cross-border financial support operations in the eurozone, and the “coupon raid” conducted by the UK Treasury on the Bank of England. Many investors have concluded that there is now an inevitable trend in place that will overthrow central bank independence throughout the developed world, allowing politicians to expand fiscal policy, while simultaneously inflating away the burden of public debt.

It seems to me that this is a very premature conclusion. While there is no denying that this is indeed the objective in Japan, the direct opposite seems to be happening in the rest of the developed world.

Why do many economists believe that much greater political control over the central banks is now inevitable? The reasons for this fall into two main categories.

First, it is argued that the central banks are now operating far outside the realms of traditional monetary policy, and have crossed the border into territory that has always been deemed to be clearly “political” in western democracies. This territory includes the allocation of credit between different sectors, the distribution of income between generations, and the fate of individual private companies in the financial sector. Since this has de facto occurred in a major way since the financial crisis, it is argued that the re-imposition of political control over these decisions is inevitable.

These arguments are to be found right across the spectrum of economics. For example, Joseph Stiglitz, a leading Keynesian who has never believed in independent central banks, said last week that it was “unconscionable that such power over the purse be given to a non-elected body”, and heavily criticised the New York Fed for bailing out its constituents in the banking system on favourable terms in 2008.

Meanwhile, John Cochrane, from the Chicago free market school, has argued that the Fed is now all-powerful, to the extent that it will not be feasible to avoid directly allocating credit and putting tax payers money at risk, thus bringing monetary policy into the political arena. Cochrane seems to regret this, perhaps preferring a less powerful Fed that can pursue traditional monetary policy outside of political control, but he thinks that Congressional control over the currently-constituted Fed will be unavoidable.

While these arguments make sense from the standpoint of political theory, I would point out that none of the recent actions of the central banks, including the 2008 bank rescues and the subsequent credit easing, have been contrary to the wishes of elected officials, such as the US Treasury secretary, the UK chancellor, or a clear majority in Congress. As a result, there are very few signs that the political process sees any urgent need to re-assert any control over central bankers in these areas. Obviously, this could change if central bankers were to become more hawkish in ways that could prove politically unpopular, but to date there is little sign of that happening either.

The second reason given for the inevitability of political control over the central banks concerns the relationship between fiscal and monetary policy. (See for example Paul McCulley and Zoltan Pozsar.) The argument runs as follows. In order to restore GDP growth, which is needed to bring down public and private debt ratios, politicians will decide that fiscal policy must shift in an expansionary direction. If higher budget deficits are financed by bond sales to the private sector, there will be problems with higher interest rates and public confidence may be eroded by rising public debt ratios.

Therefore politicians will “order” the central bank to expand the monetary base to finance the budget deficits. This will hold down the public debt ratio, and if it causes inflation to rise, that might be a welcome side effect. Any other way of solving the debt crisis, it is argued, would be politically and economically more painful, so politicians and their electorates will inevitably follow the path of least resistance.

This has now happened in Japan, but it has taken a full two decades of failing economic activity to get there. And while the outcome in Japan will presumably have powerful effects on opinion elsewhere in the world, the current situation is a long way from fiscal dominance over the central bankers. In the US, for example, the Fed has, entirely voluntarily, announced an open-ended programme of bond purchases, which will be continued until unemployment falls substantially. Furthermore, the Fed chairman has hinted that he thinks that, for a while, fiscal policy should be more supportive of economic activity.

Does that not constitute an open invitation to the fiscal authorities to run temporarily higher deficits, financed to a large extent by monetisation? Yet, instead, the fiscal authorities have just announced a budgetary tightening of 1.7 per cent of GDP in 2013, and the policy mix in the UK and the eurozone is not dissimilar. That does not fit the definition of fiscal dominance that Thomas Sargent and Neil Wallace introduced in their seminal paper (“Some Unpleasant Monetarist Arithmetic”) in 1981. In fact, it seems more like monetary dominance.

Paul McCulley recalls that in 2003, Ben Bernanke argued that there should be a compact in Japan, between two independent bodies, to raise the budget deficit and expand the monetary base. The future Fed chairman said that “greater co-operation for a time between [central banks] and fiscal authorities is in no way inconsistent with the independence of the central banks, any more than co-operation between two independent nations in pursuit of a common objective is inconsistent with the principle of national sovereignty”.

In Europe and America, it seems to be the central bankers who are pushing the politicians in unorthodox directions, not the other way around. Fiscal dominance will only become a major issue if and when the central bankers decide to tighten policy.

Gavyn Davies

Fonte: FT