Central banks have been in the news a lot lately, with Mario Draghi’s dramatic decision to redeploy the full range of unconventional policies alongside Jerome Powell’s more obvious ambivalence about loosening the monetary spigots. In part this is a function of timing. The business cycle is turning and yet central banks have not quite managed to reset their instruments after the last crisis. Part is also due to overload. Central banks have been ‘the only game in town’ for a long time, they have expanded responsibility for prudential oversight, and politicians seem none too eager to assume responsibility for macroeconomic performance. It would be a mistake, however, to focus too much on short term explanations. Three recent books explore some of the deeper forces that have pushed central bankers into the spotlight.
It would not be an exaggeration to argue, for example, that central bank independence has lost much of its political legitimacy – and central bankers know it. Central bankers may still believe that monetary policy is a technical enterprise and that by isolating themselves from politics they can make policy decisions that focus on the longer term. But the evidence is clear that people are starting to question why monetary policy should be held apart from political debate, why central bankers should be allowed to make decisions that hurt one part of society while benefiting another, and whether some new formula cannot be found to make monetary policy more accessible to stakeholders more aligned with Main Street than with Wall street. The solution is not to hand monetary policy over to elected politicians. It is to re-frame the narrative underpinning the legitimacy of central bank independence. That narrative should have at its core a certain notion of ‘financial citizenship’, within which the people take responsibility for trying to understand monetary policy-making while central bankers take responsibility for engaging more systematically and more responsively with the public.
Annelise Riles makes a powerful case for this re-engineering of the argument for central bank independence – and she is right both in her insistence than the current situation is unsustainable, and in her observation that central bankers are well-aware they can no longer count on a deferential public. Importantly, Riles also has a solution for bringing central bankers together with stakeholders from outside the financial sector and with the general public. Riles has developed a platform for engagement called ‘Meridian 180’ (www.meridian180.org) that she created originally to facilitate crisis response in the aftermath of Japan’s Fukushima disasters and that she has now broadened to foster legitimating dialog in other crisis situations. With a major financial disaster just behind us and the prospect of another looming, Riles has good reason to deploy her new forum in a search for more sustainable financial governance.
Riles points to this ‘Meridian 180’ platform only at the end of her argument, in her recommendations for how a new narrative to legitimate central bank independence can be developed. That placement is unfortunate. Time and again in the build-up to her conclusion, Riles highlights statements from key actors that she collected at ‘Meridian 180’ events. Without specific knowledge of the organization, it is easy to come away wondering whether there is some new Jackson Hole (Federal Reserve) or Sintra (European Central Bank) symposium that has popped onto the central banking conference calendar. It is also hard to appreciate the context within which those statements were made and hence the possibility that the precise choice of words might reflect this unique social environment.
None of this is to criticize Riles’ underlying analysis. She makes a good point about the cultural distinctiveness of the central banking community – not unlike the point made by Juliet Johnson in her book on the expansion of central banking into Central and Eastern Europe. Riles also makes a good point about the too-close ties between central bankers and the finance community, much like Lawrence Jacobs and Desmond King do in their study of the Federal Reserve. Finally, Riles draws heavily on Paul Tucker’s self-reflection after he left the Bank of England. Her focus is on Tucker’s attitudes toward central bank independence, but Tucker recast his thoughts in terms of independent agencies more broadly. An introduction to the ‘Meridian 180’ platform can – and should – be forgiven for not engaging more clearly and comprehensively with the many new voices challenging the isolation of policymakers from democratic politics. A reorganization of the material in this book would help readers better understand its contribution.
Currencies, Capital, and Central Bank Balances
Cultural isolation is not the only concern. Central bankers confront a wide range of problems related to the lack of coordination in monetary policy-making across countries, the impact of capital flows from one country to the next, the prolonged use of ‘unconventional’ monetary policies that have swelled the size of their balance sheets, and a very imperfect understanding of how market participants shape their expectations about future inflation. Worse, these problems are all central to the tangle practice of monetary policy-making and financial market supervision. Central bankers may dream of a different world where they can set their policies using a rule for every occasion; more often than not, however, they have to exercise judgment in a way that most non-central bankers would find hard to distinguish from making a guess.
This situation is precisely what Annelise Riles leads us to expect in her call for greater financial citizenship (see previous review). Nevertheless, it is worth reading this conference volume from the Hoover Institution to appreciate the difficulties that central bankers must face. The volume is much better than your average edited collection, where the papers rarely speak to one another. Here most of the text is transcript, which means the engagement is continuous. There are a few set pieces to start the conversation, but there are also many long comments and back-and-forth exchanges that are so artfully rendered as to give the reader a fly-on-the-wall sense. Even the papers read like they are being presented. What few formulas there are appear in a slim annex; the graphical presentation of data requires almost no explanation.
This format is important for a more general reader because it opens a door on the culture of central bankers that Riles (rightfully) finds so important to understand in her critique of central bank independence. It also offers revealing insights on just how easily top members of the central banking community are willing to concede the uniqueness of their position. An early exchange between former Bank of England Deputy Governor Paul Tucker and former Reserve Bank of India Governor Raghuram Rajan is illustrative: In his paper, Rajan provided a proposal for rules that might govern how central banks think about and respond to the impact of their own policies on other countries; Tucker pointed out that Rajan’s rules make more sense if you think about central banks engaging in monetary politics rather than monetary economics; and Rajan conceded that economics is less important than perception – ‘we need to be seen to be doing something…monetary politics has been a central feature here’ (p. 51).
Such asides show the political vulnerability of the central banking community. They also show the limitations of central banking. Some of those limitations are mechanical. Central bankers cannot force banks in the private sector to loan money into the real economy and they may have less leverage than they imagine in transmitting changes in interest rates through the banking sector to end users. Some of the limitations are also a matter of role play. Central bankers make monetary policy. In that sense, as one-time Federal Reserve Governor Kevin Warsh observed, central bankers ‘ought not be fiscal policy makers with tenure’ (p. 193). Spending money may be necessary in crisis, but in more normal times central banks should step back and allow elected politicians to make those sorts of decisions.
This collection also reveals the extent to which central bankers exist as a community, with overlapping personal relationships, a high self-awareness of one-another’s interests and achievements, and a deep respect for each other’s contributions. Here again, you get a flavor of what Juliet Johnson refers to as the ‘wormhole community’ of central bankers. Meanwhile, scholars from other disciplines who work on central banking and monetary policy-making are absent. As Riles argues, another challenge will be to widen the conversation. This is a readable collection that could have supported more diverse participants.
Fighting Financial Crises
Another way to think about the political independence of central bankers is to imagine a world where they do not exist. Such a world would still have banks and money; it just would not have monetary policy. This was the situation in the United States for much of the 18th and early 19th Century. During the latter half of that period, from the early 1860s onward, the United States (U.S.) government chartered national banks authorized to issue national currency, but it did not provide for centralized banking supervision and it also did not create facilities to bail banks out of trouble. Instead, the banks formed clubs to regulate and, when necessary, bailout each other. The U.S. Federal Reserve System emerged from and in many ways improved upon those private arrangements. But if you want to understand why central bankers are so close to large financial institutions, it is important to keep that historical development in mind. It is also important to recall the lessons private bankers in the larger, more systemically important institutions learned about how to underwrite one-another in hard times.
This is the opening premise in Gary Gorton and Ellis Tallman’s fascinating exploration of the lessons from the past for fighting the financial crises we face and will face in the present and future. Gorton and Tallman show how large, systemically important banks clubbed together in clearing houses – which are institutions where banks go to net out their payments with one-another in order to make the whole financial system work more efficiently. Banks that want to access these clearing houses, and the efficiencies those institutions had to offer, had to subject themselves to close supervision by the other members of the club. And when the financial system as a whole faced crisis, the clearing house would suddenly (and temporarily) transform itself into a joint-stock financial institution – a giant bank, owned by the large banks that constitute the core of the financial community – in order to ensure that each of the members had the money necessary to do business and that any member that failed would do so in an orderly manner and without bringing down the entire system.
This private sector arrangement did not eliminate the threat of financial instability. On the contrary, Gorton and Tallman find the ‘national banking’ period interesting because it was beset by frequent systemic crises. Nevertheless, the large banks and clearing houses did learn techniques to mitigate the impact of a sudden loss of confidence in the banking system. They learned to suspend the laws of contract, so that banks could stop redeeming short-term loans they had taken out (often in the form of ‘deposits’) in order to safeguard their liquidity; they learned to create new forms of liquidity underwritten by the major banks in the system in order to act as a lender of last resort; and, more important, they learned how to manage information so that other participants in the marketplace would not know which banks – by name – were in trouble. In this way, the major bankers were able to shift popular attention away from specific institutions and onto the ‘system as an entity’ (p. 175).
Gorton and Tallman insist that the lessons of the past still apply. If policymakers want to prevent a crisis from taking down the financial system, they have to let systemically important banks break the law of contract (temporarily), they have to ensure those banks have sufficient liquidity, and they have to manage access to information in order to force the public to look away from institutional accountability and to focus on the requirements for shoring up the system as a whole. These recommendations will be challenging for anyone looking for transparency in central banking. Gorton and Tallman agree that transparency is useful in the periods between crises but argue that it is counterproductive when the financial system is in jeopardy. Their book is essential reading that should spark a wider conversation.
Financial Citizenship: Experts, Publics and the Politics of Central Banking. By Annelise Riles. Ithaca: Cornell University Press, 2018. X + 108 pp.
Currencies, Capital, and Central Bank Balances. Edited by John H. Cochrane, Kyle Palermo, and John B. Taylor. Stanford: Hoover Institution Press, 2019. Xviii + 350 pp.
Fighting Financial Crises: Learning from the Past. By Gary B. Gorton and Ellis W. Tallman. Chicago: The University of Chicago Press, 2018. X + 234 pp.