As the North Atlantic economies continue to stumble from crisis to crisis, their central bankers have seemingly abandoned the belief that they should not look beyond inflation control. A new spirit of eclecticism has taken hold. Take a look at what has happened in the past few weeks.
In the US, the Federal Reserve (Fed) has said that it will keep short-term interest rates at near-zero levels till at least mid-2013, in response to a stuttering economy and a deep jobs crisis in the world’s largest economy. One senior US central banker—Charles Evans of the Chicago Federal Reserve Bank—has even suggested in a recent speech that there should be an explicit link between interest rate policy and unemployment levels. Evans said the Fed could indicate that the federal funds rate will be kept low till “the unemployment rate falls substantially”, but as long as the “medium-term inflation stayed below 3%”.
The Fed actually has a dual mandate to maintain price stability and support maximum employment, though its focus has been skewed towards the former objective in recent decades. The European Central Bank (ECB) was set up with only one task in mind: maintaining low inflation.
Also Read | Niranjan Rajadhyaksha’s previous columns
Yet, it has been forced to douse other fires in recent months. ECB has been busy trying to prevent a default in countries such as Greece. Interest rates on Greek bonds have climbed and, despite internal dissensions, ECB has been buying these bonds in a bid to reduce the borrowing costs of the Greek government, which is already struggling with an immense fiscal crisis. A blowout in Greece could threaten not only the stability of German and French banks that hold Greek bonds, but also the ambitious European integration project. ECB has emerged as an important player in the attempt to cap the European financial crisis.
Meanwhile, the Swiss National Bank (SNB) has said it will intervene in the currency market to defend a particular value of the currency it manages. SNB moved to prevent any further appreciation of the Swiss franc, a safe-haven currency that nervous investors have frantically bought in response to the recent wave of fear that has lashed Europe. The growing strength of the Swiss currency was threatening to undermine the competitiveness of the underlying Swiss economy. A few Swiss companies had even threatened to move operations out of the country, as financial flows were threatening the real economy of output and jobs.
The central bank has said it would keep the price of one Swiss franc below €1.20, by being “prepared to purchase foreign exchange in unlimited quantities”. To make these purchases, the Swiss bank will have to print unlimited quantities of francs with which to buy euros. In effect, this would be yet another case of quantitative easing.
So, we have the talk in the US about using monetary policy to explicitly target inflation, moves in Europe to improve financial stability and an attempt in Switzerland to target the exchange rate. In other words, these central banks are looking beyond inflation and are trying to control other economic variables. This flies in the face of the widespread belief that central banks should do nothing other than target domestic price stability.
The Reserve Bank of India (RBI)— which has multiple targets rather than just inflation control—had come under immense pressure in the years leading to the financial crisis to transform itself into an inflation-targeting central bank, rather than look at other tasks such as maintaining financial stability, intervening in the foreign exchange market and overseeing the adequate provision of credit to producers and consumers. The calls for it to change its ways were completely in tune with the prevailing orthodoxy in the West.
In that sense, the Indian central bank has been ahead of the curve rather than behind it as far as its understanding of the role of a central bank goes. RBI is not beyond reproach, but it has proved that it has a better understanding about what needs to be done than many of its very vocal critics. Its eclecticism in terms of monetary policy targets and instruments has served us well.
The global economic problems of the past few years could be a turning point for economic management. Fiscal policy has acquired a new heft as governments have increased public spending to support effective demand, though the downside of this has been the sovereign debt crisis in many developed economies. The increasing use of quantitative easing shows that central banks are now looking beyond interest rates as the only tool of monetary management. The recent weeks show that issues such as unemployment levels, exchange rates and financial stability are no longer off the table.
There is still no new consensus to replace the old one. The world could be moving into an era of policy experimentation.
Niranjan Rajadhyaksha is executive editor of Mint. Comments are welcome at firstname.lastname@example.org