Power, philosophy and heroism of central bankers

Who will prevail in the fight to distribute the guilt as some major industrial countries teeter toward stagflation? The answer will not be clear for months or even years. Russia’s invasion of Ukraine accelerated the already perceptible rise in inflation in major countries. This sharpened the dilemma for central bankers over whether, when and how to risk unpopularity by tightening monetary policy that had been too accommodative until then. And it has accentuated the blame game in which politicians and central bankers joust to censure each other for the policy mistakes that caused the biggest surge in inflation in 40 years.

All of this forms the backdrop for a thoughtful book on central banking economics by Jagjit Chadha, director of the National Institute for Economic and Social Research, Britain’s oldest independent research institute. Money Minders covers the broad theoretical and philosophical range of central banking policy-making. Chadha provides particular insight into the dilemmas behind the reliance on massive purchases of government bonds through quantitative easing after the 2008 financial crisis. He rose to prominence in June accusing the UK Treasury of cost taxpayers £11billion by failing to take out insurance on interest rate hikes, depleting the £895billion worth of reserves created by QE.

Chadha acknowledges that central banks have now likely irreversibly crossed the threshold into the political arena. His book on the technical aspects of money and credit is a useful supplement to a separate work on central bank governance by Paul Tucker, former Deputy Governor of the Bank of England.

The line between these issues can be painfully narrow. After the outbreak of war in Ukraine, I predicted that central bankers would retreat from a full-frontal assault on inflation – diplomatically moving away from the purest interpretation of their mandates, and gaining popularity and popularity in the process. After a month in which the Federal Reserve raised rates (for the second consecutive meeting) by 0.75 percentage points, and the BoE and the European Central Bank by 0.5 points, this forecast might seem wrong. The BoE, which extended QE for far too long last year, must gradually dismantle a large monetary surplus that has aggravated price pressures. Faced with an inflation rate that will peak at 13% this year – two and a half times higher than its forecast of just nine months ago – the BoE is talking about a prolonged recession.

Despite all this, on closer inspection, central bankers are still doing well. Jacques de Larosière, former governor of the Banque de France and a great critic of overly accommodating monetary policies, recalls that inflation rates in terms of are still largely negative in the major industrialized countries. De Larosière has repeatedly argued that central banks should have accelerated “normalization” by starting to raise rates last year. The ECB decided belatedly to put an end to generalized QE and negative interest rates. But it has launched its transmission protection instrument – ​​the crucial legal and technical details of which are still being worked out by ECB committees – to guard against excessive rate hikes in the bond markets of the largest members. indebted to the euro. Europe’s inflation rate is expected to remain at 4%-4.5% over the next year, falling from 9.6% in July (lower to 7.5% in Germany) as prices soar energy fades. This is still far from the medium-term target of 2%, which is hardly a sign that central banks are braking heavily.

In the United States, there is good reason to believe that Jerome Powell, the chairman of the Federal Reserve, wanted to delay active tightening measures before his reappointment in November 2021 by President Joe Biden for a second four-year term. This stemmed less from a specific desire to safeguard its own position than from the fact that earlier Fed rate hikes would have triggered calls from the Democratic Party for an outspoken dove to take the reins in February 2022 – with a deleterious effect on inflation. prospects.

In the meantime, central bankers around the world face complaints of complacency and delay. Andrew Bailey, Governor of the Bank of England, has drawn the wrath of Liz Truss, head of the list of the contest to become British Prime Minister after September 5. Australia launched what Truss proposed for the UK – a full-scale review of its central bank’s policy framework, after Phil Lowe, Governor of the Reserve Bank of Australia, called forecasting errors ” “embarrassing”. ECB President Christine Lagarde said in December 2021 that “under current circumstances” rate hikes in 2022 were “very unlikely” – but did not yet signal any obvious unease.

Tragedy and triumph usually linger together. In his book, Chadha expresses the hope that “behind the scenes” recalibration of central bank instruments and models will allow monetary policymakers to play a “heroic role…in averting the Athenian tragedy.” In an inflationary environment similar to today, Arthur Burns, the supremely unheroic Fed chairman in 1970-78, gave a farewell lecture in 1979 on power and philosophy in which he thought about the “angst” of central bankers – the prelude to a (but painful) success. ) assault on rising prices by Paul Volcker. The best central bank governors don’t need to be (and probably shouldn’t) be heroes. But the politicization of the world’s central banks puts heroism – and, if necessary, the will to die a martyr – a little higher in the list of their necessary attributes.

David Marsh is President of the OMFIF.