Whither central banking?
This question has fallen by the wayside in the fever-pitch Renaissance drama that is Donald Trump’s Washington. Pundits and legislators are more captivated by swirling allegations of Russian collusion and White House infighting than by the relatively mundane domain of monetary policy. But that doesn’t mean we should overlook the first signs of what could be a momentous change in the way we do central banking in the 21st century.
The typical model of central banking is that of independence. The central bank is given a mandate by the national — or supranational, in the case of the European Union — government. Politicians may nominate officials to the governing boards of the central banks, but nominees’ terms are long, so for the most part central banking remains a technocratic endeavor, largely insulated from the capriciousness of domestic politics. As former Fed vice chair Alan Blinder argued in the mid 1990s, monetary policy is a technical practice that requires specialists with long-term outlooks at the helm; achieving the desired goal requires patience and prudence far beyond that of politicians, who by design are incentivized to think and act in the short term.
In recent months, however, a growing chorus of voices — from left, right, and center — has come to question the foundations of this model. How independent, they ask, should central banks really be? A decade on, what are the lessons to be gleaned from the banks’ conduct during the 2008 financial crisis? What is the appropriate balance between technocratic expertise and the political process in a liberal democracy?
The starkest questioning of central-bank independence has come, somewhat surprisingly, from the liberal center. In the pages of the Financial Times, the columnist Wolfgang Munchau has argued that “the independence of a central bank is politically justifiable only when the central bank targets a single policy variable. . . . The presence of two goals implies that trade-offs have to be made, which is a fundamentally political task.” To Munchau’s mind, though the independence of the European Central Bank, with its single mandate to achieve price stability, might be defensible, a similar status for the Federal Reserve, which is tasked with achieving both price stability and full employment, is more dubious. But, he points out, this line of defense for central-bank independence presupposes a wide consensus on the appropriate goals for central bankers to pursue. The Fed’s institutional independence was developed in the aftermath of the inflation crisis of the 1970s, when policymakers of all stripes agreed that monetary policy should aim to lower inflation. In the world created by the financial crisis, though, that sort of consensus has disappeared, and the case for independence — in which a savvy elite is entrusted to achieve a set of consensual goals — has accordingly weakened.
A similar argument comes from Ryan Avent of The Economist¸ another denizen of the liberal center. Avent’s essay explores the Fed’s conduct during the Great Recession and the lessons we can learn from it. In his telling, the Fed acted far too cautiously throughout the crisis and recovery, always focused on ensuring interest rates stayed low enough to keep inflation below the target of 2 percent; bold steps went untaken, eschewed in favor of extreme caution. He sees this as an institutional indictment of modern central banking. The Fed failed, he argues, and if we are to avoid a similar catastrophe, we must reform the system.
Where the citizenry at large might have once felt comfortable entrusting vast powers to unaccountable technocrats, the pendulum has decidedly flipped in the other direction.
“Central bankers,” Avent writes, “see themselves as technocrats, there to tend the monetary machinery. They can change the oil and top up the tanks, but are not constitutionally disposed to swapping out the engine.” Radical change can occur only through drastic political action, he argues, because central banks themselves are incapable of self-correcting. The change he prefers would amount to a “shift in the priority of policy and an adjustment in the mechanisms through which that goal is achieved”; perhaps central banks would begin to target nominal GDP rather than inflation, through public-works programs, infrastructure projects, or the establishment of a universal basic income.
These are radical ideas, though not particularly new ones — the economics blogosphere has floated them for years and liberals criticized Fed policy as too wary of inflation from early on in the recession. Jeremy Corbyn, leader of Britain’s Labour party, has suggested that the Bank of England embark on a program of “People’s quantitative easing,” which would essentially see it fund public infrastructure projects. Centrist liberals have predictably responded that this would amount to nothing less than the destruction of the Bank of England’s independence, which was secured scarcely two decades ago.
That such proposals are even discussed as possibilities today is a testament to the sea change in our political climate. Though they might upend one of the basic institutions of the liberal financial order, they ring in odd harmony with the politics and society of our time. One of the predominant themes of the great upheavals of 2016 was a decaying sense of trust between people and elite; where the citizenry at large might have once felt comfortable entrusting vast powers to unaccountable technocrats, the pendulum has decidedly flipped in the other direction. Though this new mood is most succinctly encapsulated by the know-nothingness of Donald Trump and Nigel Farage, it echoes in the rhetoric of Bernie Sanders and the concrete proposals of Corbyn, his English equivalent, too.
Indeed, the past few years have seen nothing less than monumental shifts in the way we understand the liberal order of which globalization is the hallmark. Whereas this process was once viewed as a rising tide destined to lift all boats eventually, we are now more comfortable candidly discussing winners and losers, recognizing that globalization’s impact on the hopeful Filipino immigrant differs greatly from its impact on middle-aged males in the Rust Belt. Independence could be safely maintained so long as we sheltered ourselves behind the illusion that central banking steered well clear of political calculations regarding its distributional effects. Now academics are looking into that illusion with interest, and the case for absolute independence is a harder one to make. In a world where government is widely reviled rather than trusted, where citizens live in a state of antagonism with both their fellow countrymen and their nation’s leaders, where the filter of partisanship colors all manner of political and cultural views, the delegation of supreme economic authority to a politically independent, allegedly nonpartisan body begins to look too anomalous to survive.
Janet Yellen’s term as chair of the Fed ends next February. At that point, President Trump will presumably nominate her successor and fill other vacancies on the Board of Governors. Should these nominees mark a shift away from the model that has characterized central banking since the 1970s, they could well prove the most consequential legacy of his presidency.