A CENTRAL BANK’S reputation is determined as much by its relationship with the government as by its handling of financial crises and economic downturns. Over the past 300 years, as governments have sought to enhance or sometimes restrict central banks’ powers, the mood has varied from collaborative and harmonious to antagonistic and fractious. By the end of the 20th century the tone had shifted to a grudging respect. Politicians came to learn that they interfered with central banks at their peril. The technocrats were told to aim for some combination of low inflation, high employment, a stable financial system and a reliable currency, and were mostly left alone to get on with the job.
As this special report has laid out, the line between intrusive politics and independent central banking is now blurring again. This is not just because central banks have bought vast quantities of public debt in an attempt to shore up economies. They have also come closer to disbursing implicit subsidies on their own account. During the pandemic they did this to keep firms alive. Now they are mulling schemes to deal with such issues as climate change. They are being pressed to solve various social problems. And they are toying with digital currencies that, in their most radical form, could expand their role in allocating credit further still.
This expansion in powers echoes across the emerging world. Central banking in the rich world has inched towards the approach in China, with its greater emphasis on its balance-sheet and credit guidance, and its multiplicity of aims. The PBoC tends to be called in to solve economic problems, says one observer, because it is regarded as more competent than other ministries. The existence of targeted-lending schemes has made it easier for the PBoC to nudge credit towards green borrowers. And among large economies, China was the first to put a digital currency to the test.
In the rich world, central banks’ greater use of their balance-sheets was to a large degree unavoidable as they sought to deliver their mandated goals. Unable to pull the lever of interest rates, they were forced to experiment with new tools. The exceptional circumstances of the pandemic justified a wide, indiscriminate safety-net. It would equally be foolish for central banks to ignore emerging risks and technologies. Geopolitics will become a more important influence on their decisions. Governments may instruct central banks to issue digital currencies. And understanding how climate change could affect the economy and the financial system is a vital task.
Laser focus
What should be fiercely resisted, however, is the endless addition of new policy goals. For one thing, as the examples of climate change and inequality show, not all problems can be fixed by monetary policy. Even in China economists have concluded that it is too blunt a tool to wield against long-standing structural woes. And in democracies the question of how best to subsidise the worthy or tax the unworthy is surely better left to elected and accountable politicians, rather than to technocrats.
Central banks were given independence so as to focus on a narrow remit. That explains why they retain legitimacy in the eyes of the public. But to heap more tasks on central banks risks pulling them into the political sphere, opening them up to ever increasing demands. That would undermine their position as neutral technocrats and could, ultimately, raise doubts about their independence. A survey by Ms Binder and Ms Skinner, the two academics, found that college-educated Americans were much more amenable to the Fed playing an active role in tackling climate change and inequality than those without a college education.
More important today, considering that inflation in the rich world is running at around 8%, is that a proliferation of aims would interfere with the tasks that only central banks can do. For as long as inflation was low, central banks may have seen little harm in venturing into new areas. Its resurgence should serve as a timely reminder of why they were given independence in the first place, and why their mission matters. Pressing social problems may continue to make them seem like convenient dogsbodies to governments. The real question for them now is whether they can control inflation, and at what price. Focus on their core job will remain crucial. ■