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Business News/ Opinion / Columns/  A broader agenda for central banks will risk their autonomy
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A broader agenda for central banks will risk their autonomy

Mixing up stability goals with others will invite political control

The Bank of England has recently had a change in its remit (Photo: Reuters)Premium
The Bank of England has recently had a change in its remit (Photo: Reuters)

Central bankers and journalists will assemble for the virtual Jackson Hole conference later this week. Their agenda will be broad. The future path of quantitative easing (QE), the health of the labour market, and other critical monetary and regulatory matters will command centre stage. But we can also expect pronouncements on issues once considered the domain of elected politicians, including climate change, racial justice and inequality.

Central-bank commentary on political issues is a significant departure from the practice just a generation ago. Central bankers who lived through the 1970s’ high and volatile inflation saw independence as essential to the ability of central banks to maintain economic stability. And this autonomy went hand in hand with clear goals and mandates, like inflation targets.

The global financial crisis and its aftermath greatly expanded the role of central banks. Large-scale asset purchases, or QE, went beyond money creation and extended to allocating credit through the purchase of non-federal government instruments and private obligations such as corporate bonds. And the scale of money creation created a political interest in its continuation. The stock of assets purchased under QE now stands at 30% of gross domestic product in the US and 40% in the UK.

Amid widespread frustration with the inability of elected policymakers to address critical issues of the day, influential voices increasingly called on central banks to step in. Central banks became “the only game in town". Central bankers responded willingly, moving into the political arena. This began most notably with climate change and the formation of the Network for Greening the Financial System (NGFS). But it didn’t stop there. Central-bank officials now concern themselves with a wide array of policy issues, from racial justice to inequality, from education to public health. These are serious challenges to societies. But the gravity of an issue is not the sole, nor even the most important, criterion for central-bank involvement. Some problems warrant a monetary response. Most do not.

It is true that many of those new issues have economic implications. Pollution, climate change and declining biodiversity affect the economy. But attempts to shoehorn these matters into the domain of monetary policy ask too much of central banks. In a world of radical uncertainty, their economists struggle to handle even their usual responsibilities of economic forecasting. Recent inflation overshoots, following a decade of persistent undershoots, suggest a need for greater humility. Central banks’ increasing focus on climate change is particularly odd. As the pandemic has shown, the financial system faces a range of tail risks ranging from cyberattacks to political instability around the world. But central banks have little expertise in any of these areas. A recent paper from the Bank of England noted, for instance, the lack of any objective metric by which to ‘tilt’ its purchase of corporate bonds to influence companies’ efforts to reduce their carbon emissions.

Regulators can best deal with financial risk with robust capital and liquidity regulation, and by insisting on operational resilience. And central banks’ most effective tool for protecting people with low incomes and few financial assets is already embedded in existing monetary practice: namely, ensuring low and stable inflation so that living standards aren’t eroded.

The new and broader ambitions of central banks have profound implications for their independence. Consider recent calls in the US to target the unemployment rate of particular groups and regions. The mere appearance of joining debates on public-health measures or state supports for the unemployed makes it harder to maintain the independence necessary for the effective conduct of monetary policy. Already, central banks seem attuned to the preferences of elected leaders even without actual changes to their mandates. Was it a coincidence that in the weeks after President Joe Biden’s election, the Fed joined the NGFS?

Such offerings are unlikely to satisfy partisan political actors. Once politicians see that central banks bend to pressure, they’ll push harder. Concessions will then spur demands for more and central banks will be pressed to go beyond managing money supply and overseeing the financial system. Wider central-bank mandates, as with the Bank of England’s recently-changed remit and the European Central Bank’s commitment to a role confronting climate change, may become more frequent. And, as politics weighs more heavily in their calculations, central banks will find it harder to do what they are uniquely qualified to do: provide financial stability. Economies are most likely to flourish when central banks are free to act independently, guided by sound economic judgement and not short-term political expediency.

Mervyn King & Dan Katz are, respectively, former governor of the Bank of England; and a former senior advisor at the US Treasury Department.

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Published: 24 Aug 2021, 09:46 PM IST
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