Central Banks Are Risking Their Independence

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, the health of the labor market, and other critical monetary and regulatory matters will command center stage. But we can also expect pronouncements on issues once considered the domain of elected politicians, including climate change, racial justice and inequality.

The emergence of central-bank commentary on hot-button political issues is a significant departure from the practice of just a generation ago. Central bankers who lived through the 1970s remembered the experience of high and volatile inflation. They 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, such as inflation targets.

The global financial crisis and its aftermath greatly expanded the role of central banks. Large-scale asset purchases — “quantitative easing” 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 inevitably created a political interest in its continuation. The stock of assets purchased under QE now stands at 30% of gross domestic product in the U.S. and 40% in the U.K. The introduction of forward guidance encouraged the view that central banks could predict the future path of the economy, rather than react to the data as they emerged.

Amid widespread frustration with the inability of elected policy makers to address the critical issues of the day, influential voices — including politicians, economic luminaries and the general populace — 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 our societies. But the gravity of an issue is not the sole, nor even the most important, criterion for central-bank involvement. Some of society’s problems warrant a monetary response. Most do not.

It is true that many of the new issues attracting central-bank attention have economic implications. Clearly, pollution and its effects, including climate change and declining biodiversity, will 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 traditional 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 — from whatever source — 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.

Most important, the central banks’ new and broader ambitions have profound implications for their independence. Consider recent calls in the U.S. to target the unemployment rate of particular groups and regions. States that lifted pandemic-related restrictions and ended supplemental unemployment benefits generally have lower jobless rates than those that retained them. Should the Federal Reserve target Nebraska’s 2.3% unemployment rate, or New York’s 7.6%? The mere appearance of joining highly charged 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 in the absence of actual changes to their mandates. Was it a coincidence that in the weeks following President 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 all the harder. Concessions will spur demands for more, and central banks will be pressed to go beyond managing the money supply and overseeing the financial system. Wider central-bank mandates, as with the recent change to the Bank of England’s 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 monetary and financial stability.

Economies and societies are most likely to flourish when central banks are free to act independently, guided by sound economic judgment and not short-term political expediency.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Mervyn King was governor of the Bank of England from 2003 to 2013. He is the Alan Greenspan Professor of Economics at NYU Stern School of Business and professor of law at NYU School of Law, and author (with John Kay) of “Radical Uncertainty: Decision-Making Beyond the Numbers.”

Dan Katz served as a senior advisor at the U.S. Treasury Department from 2019 to 2021 and is a co-founder of Amberwave Partners.

©2021 Bloomberg L.P.

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