Central Banks on Trial

Howard Davies is sympthatic about Central Bankers.

His article in PS.

He states that in this century Central bankers have gone from zero to hero and now back on trail again. Now doubt there role is now very much expanded:

Central banks’ balance sheets have expanded dramatically, and new laws have strengthened their hand enormously. In the United States, the Dodd-Frank Act has taken the Fed into areas of the financial system which it has never regulated, and given it powers to take over and resolve failing banks.

In the United Kingdom, bank regulation, which had been removed from the BoE in 1997, returned there in 2013, and the BoE also became for the first time the prudential supervisor of insurance companies – a big extension of its role. The ECB, meanwhile, is now the direct supervisor of more than 80% of the European Union’s banking sector.

In the last five years, central banking has become one of the fastest-growing industries in the Western world. The central banks seem to have turned the tables on their critics, emerging triumphant. Their innovative and sometimes controversial actions have helped the world economy recover.

But with great power comes great responsibilities:

There are two related dangers. The first is encapsulated in the title of Mohamed El-Erian’slatest book: The Only Game in Town. Central banks have been expected to shoulder the greater part of the burden of post-crisis adjustment. Their massive asset purchases are a life-support system for the financial economy. Yet they cannot, by themselves, resolve the underlying problems of global imbalances and the huge debt overhang. Indeed, they may be preventing the other adjustments, whether fiscal or structural, that are needed to resolve those impediments to economic recovery.

This is particularly true in Europe. While the ECB keeps the euro afloat by doing “whatever it takes” in ECB President Mario Draghi’s phrase, governments are doing little. Why take tough decisions if the ECB continues to administer heavier and heavier doses from its monetary drug cabinet?

The second danger is a version of what is sometimes called the “over-mighty citizen” problem. Have central banks been given too many powers for their own good?

Quantitative easing is a case in point. Because it blurs the line between monetary and fiscal policy – which must surely be the province of elected governments – unease has grown. We can see signs of this in Germany, where many now question whether the ECB is too powerful, independent, and unaccountable. Similar criticism motivates those in the US who want to “audit the Fed” – often code for subjecting monetary policy to Congressional oversight.

There are worries, too, about financial regulation, and especially central banks’ shiny new macroprudential instruments. In his new book The End of Alchemy, former BoE Governor Mervyn King argues that direct intervention in the mortgage market by restraining credit should be subject to political decision.

Others, notably Axel Weber, a former head of the Bundesbank, think it is dangerous for the central bank to supervise banks directly. Things go wrong in financial markets, and the supervisors are blamed. There is a risk of contagion, and a loss of confidence in monetary policy, if the central bank is in the front line.

So the role of CB where the distinction between fiscal and monetary policy burrs, there Central banker not being accountable to people( read legislative) is a double edged sword. Any stumbling of CB is going to subdue their autonomy, and hence so much positive spillover with it.


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