Friday, June 7, 2013

Central Banking’s New Face

by Paola Subacchi

LONDON – A changing of the guard is underway at many of the world’s leading central banks. Haruhiko Kuroda is now installed as the governor of the Bank of Japan (BOJ), faced with the daunting task of ending two decades of stagnation. Mark Carney, the Bank of Canada’s current governor, who is set to take over as the governor of the Bank of England (BoE) in July, is already making his presence felt in British monetary-policy debates. And in the United States, the expected conclusion of Ben Bernanke’s term as Chairman of the Federal Reserve Board in January is already inviting speculation about his successor.

This illustration is by Margaret Scott and comes from <a href="http://www.newsart.com">NewsArt.com</a>, and is the property of the NewsArt organization and of its artist. Reproducing this image is a violation of copyright law.

Illustration by Margaret Scott

The only holdouts among the world’s leading economies are the eurozone and China. But that does not necessarily imply constancy. Mario Draghi has been the president of the European Central Bank for barely a year, and the governor of the People’s Bank of China, Zhou Xiaochuan, was almost replaced when he reached retirement age in February.

Twenty years ago, such developments would have interested mostly bankers and businesspeople. But, since the global financial crisis, the need to revive and sustain economic growth in the US, the United Kingdom, and Japan – and to avoid financial collapse in the eurozone – has prompted major central banks to be more outspoken and pursue more aggressive monetary policies, including unconventional measures like quantitative easing (QE). As a result, many central bankers have become household names; some even have tabloid nicknames, like “super Mario” Draghi.

This new prominence has also forced some central bankers to reassess their decision-making processes. In Japan, outsiders recently got a rare glimpse into the BOJ’s activities when minutes of a policy meeting were leaked. Likewise, the accidental release a day early of the minutes from the Fed’s March rate-setting meeting to more than 100 people, including banking executives, congressional aides, and bank lobbyists, raised questions about how the bank controls the disclosure of privileged information.

In fact, the Fed has been under increasing scrutiny since 2008, when near-zero nominal interest rates drove it to become the first central bank to adopt QE. In a push to reduce the cost of borrowing, the Fed purchased long-term assets in the market, injecting liquidity into the financial system. The BoE and the ECB have since adopted similar measures.

In early April, the BOJ announced plans to unleash the most aggressive bond-buying program of all, promising to inject $1.4 trillion into the economy over the next two years in order to meet an inflation target of 2%. This is monetary policy on steroids, and, to opponents of inflation-inducing money creation, it amounts to playing with fire. But, for Japan, which has been struggling with deflation for a generation, it is a risk worth taking. Whether Kuroda’s assault will bolster domestic consumption and investment remains to be seen.

Unconventional measures are part of a broader transformation of monetary policymaking. In addition to becoming bolder and more expansive, it has become increasingly intertwined with fiscal policy. This is most explicit in Japan, where monetary policy is a central component of Prime Minister Shinzo Abe’s economic strategy, dubbed “Abenomics,” implying collaboration between the government and the central bank.

Does this undermine central-bank independence by amounting to a de facto subordination of unelected technocrats to elected politicians? Arguably, Japan is an exceptional case, with the constraint of the zero bound on nominal interest rates demanding, at long last, a deviation from conventional measures. In Europe, however, Bundesbank President Jens Weidmann has criticized the ECB for overstepping its mandate with its “outright monetary transactions” program, through which Draghi aims to fulfill his pledge to guarantee the euro’s survival.

As a result, questions about the role of monetary policy and the independence and accountability of central banks, once confined to rarefied academic discussions, are fixtures of broad policy debate. But, rather than try to define a single approach, central bankers should aim to develop individualized approaches within the orthodox monetary-policy framework, which revolves around price stability and independence.

For example, the Fed’s mandate dictates that price stability can be explicitly linked to active support for GDP growth and employment; for the BoE and the ECB, it can be a condition for achieving the broader goal of sustainable growth and employment. As long as politicians observe the rule of non-interference – at least publicly – central banks will be perceived as unconstrained by political interests.

The BOJ, by demonstrating that aggressive money creation is a legitimate approach to fighting deflation, has broken previously sacrosanct conventions. At the same time, it has taken the unprecedented step of incorporating monetary policy into a comprehensive economic strategy based on coordination among different policy areas and their associated institutions.

This integrated approach could prove effective in countries where the real economy and the financial sector are closely linked, ensuring the timely, orderly implementation of policies, while preventing adverse spillovers. Such coordination would infringe on central-bank independence no more than multilateral cooperation undermines the sovereignty of the countries involved.

While the impact of Abenomics on Japan’s economy remains to be seen, its impact on debates about monetary policy and the relationship between central banks and governments is already becoming apparent. One hopes that Carney will follow this trend of challenging conventional wisdom at the BoE. A new era of active and varied monetary policy may have begun, with potential benefits for all.

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