Central banks are never independent from politics. The bankers who run those organizations may have the institutional power to define their own objectives, the technical capability to adjust the settings on their monetary instruments, and strong legal protections around the terms and conditions for their employment. But none of that is enough to insulate them from politics. Determined politicians will find a way to exercise influence, no matter what the obstacles. More often than not, such politicians will do so without even implicating the legislative process. They do not have to rewrite the laws to violate central bank independence. Politicians only need to take advantage of the fact that central bankers come from society, they (and their families) have to live somewhere, and eventually they will also retire.
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.
At some point in the early months of 2007, the words ‘sub-prime mortgages’ began to filter into the popular press. By the end of that August, they were ubiquitous. This small section of the high-risk, high-yield housing finance market in the United States sparked a global financial and economic crisis that would scar a generation. The stories that emerged to explain how this happened were the stuff of fiction or perhaps something even stranger. Banks booked mortgages to people with no demonstrable assets or income, at introductory rates that quickly reset to terms that only the most resilient of households could afford. By the time the borrowers defaulted, however, the banks had sold the mortgages to other investors using complicated securitization instruments that effectively hid the risks involved. The institutions left holding the bag were not only unaware of the dangers the faced but completely unprepared for the consequences. In his powerful new book on The Political Economy of Housing Financialization, Gregory W. Fuller explains why that happened, how the dynamics differed across countries, and what we might do to anticipate similar crises in the future.
International political economy used to be about wealth and power. Now the sources of influence and control are more subtle. Governments choose to follow rules that are not enforced, they sign onto policies recommended to them by foreign nationals (or even ‘citizens of nowhere’), and they invite powerful non-state actors to assume control over crucial economic sectors, finance in particular. Three recent books explain why this is so.
Europe’s heads of state or government have launched a new conversation about reforming the financial structures of the European Union in order to prevent another economic and financial crisis like the one that consumed the last decade. They have a number of ambitious proposals on the table — to complete the European Banking Union, to strengthen the European Stability Mechanism, and to enhance political accountability at the European level. Not all of these proposals are sure to be adopted, and progress is likely to be incremental. The goal of ensuring financial market stability is nevertheless apparent.
It is no secret that the economics profession is struggling to learn the lessons taught by the recent crisis. Two new books show where that thinking is headed. The End of Theory, by Richard Bookstaber, emphasizes the importance of focusing analysis on the world as it is, rather than on a more formal universe that is easier to model. Adaptive Markets, by Andrew Lo, explores how much we could benefit from learning to tap the potential of modern finance.
Oxford University Press has published two new books on the political economy of the euro area that should be required reading. One, by C. Randall Henning, explains why the International Monetary Fund has become a central actor in the stabilization of the euro area; another, by Waltraud Schelkle, sheds new light on what the single currency has to offer both in its current form and looking to the future. My reviews of both books are below.
Economic governance is in the eye of the beholder. The French want discretion, flexibility, and effective crisis management; the Germans want rules, discipline, and effective crisis avoidance. The euro as a single currency reflects both tendencies. There are aspects of Europe’s macroeconomic framework that are flexible and responsive (like the European Central Bank) and aspects that are more rigid and formulaic (like the ‘six pack’ and ‘two pack’ of policy coordination procedures that strengthen the ‘Stability and Growth Pact’). The challenge for Europeans is to find a sustainable balance. Too much of either tendency is not only unacceptable to one side or the other in the Franco-German partnership, it is also unlikely to work in stabilizing either the euro as a single currency or the European Union as a political project.
The surprise victory of Donald J. Trump in the United States (US) presidential elections briefly pushed the euro, the Swiss franc, and the Danish kroner up against the dollar. It also pushed down the yields on high quality sovereign debt and it temporarily sent equity markets into the red. This was all to be expected. Like almost everyone, market participants thought Hilary Clinton would gain the White House alongside a predominantly Republican Congress. They placed their bets to take advantage of another four years of competent administration and legislative logjam. A Trump victory upset that calculation and so some of those market participants were trying to safeguard their capital until they could get a better sense of what is happening. The assumption they made was that Europe can act as a safe-haven. Unfortunately, that assumption is mistaken.
The European Central Bank (ECB) announced a raft of policy measures on Thursday, March 10, intended to give a further boost to euro area economic performance. Most of these measures were unconventional and yet still precedented. The ECB lowered its main policy rates, accelerated the pace of its asset purchases, and widened the pool of assets eligible to be included in its purchasing program. It also renewed its program for targeted loans to banks that extend credit to the non-financial sector. The only new element was the rate of interest that the banks would pay to access credit that they could lend for investment. The question is whether that new wrinkle will make much of a difference. As is often the case, the answer depends less on the mechanics of monetary policy than on the magic of market ‘confidence’.