The Death of the Central Bank Myth
"For decades, monetary policy has been treated as technical, not political. The pandemic has ended that illusion forever."
"If it was not already evident, the COVID-19 shock has made clear beyond a shadow of a doubt that both the political and economic circumstances out of which the original model of central bank independence emerged have changed, not just in Germany or Europe but around the world. This renders the classic paradigm of inflation-fighting independence obsolete and has thrown into doubt models of narrow delegation. To address the new circumstances in which the real problems are the threat of deflation, the stability of the financial system, and the passivity of fiscal policy, the ECB, like all its counterparts, has indeed been pursuing a policy that goes well beyond price stability conventionally understood. In fact, in Europe the ECB is the only agency engaged in economic policy worthy of the name. Given the limitations of its mandate, this does indeed involve a degree of obfuscation. Despite itself groping in the dark, the Karlsruhe decision has helpfully put a spotlight on the ECB charade.
To respond by doubling down on a defense of independence may be inevitable in the short run. But this too will run its course. The more constructive response would be to advocate for a wider mandate to ensure that the central bank does indeed balance price stability with other concerns; the bank’s second objective should surely be employment and not the interests of German savers. But an open debate about the range of the ECB’s mandate would be a step forward for European politics. The politics of treaty adjustment are not easy, of course. It will take political courage. But the demand itself should not be presented and dismissed as outlandish. After all the Fed has a dual mandate. Alongside price stability, it is enjoined by the Humphrey-Hawkins Act to aim for the maximum rate of employment possible. As the history of the Fed attests, this is far from being a binding commitment. But since 2008 it has provided the Fed with the latitude necessary to expand its range of activities.
That expansion of activity has in large part been a matter of technocratic discretion. The point of pushing for a discussion of a widening of the ECB’s mandate should be the opposite. The aim should be to encourage a wide-ranging discussion about the wider purpose of central banks. Again, the U.S. example may be an inspiration. The Fed’s dual mandate is, somewhat surprisingly, a legacy of progressive struggles fought in the 1960s and 1970s—specifically, by the civil rights movement under Coretta Scott King’s leadership—to force social equity to the top of the macroeconomic policy agenda. This may seem far-fetched, but progressives cannot shrink from the challenge. They should not allow themselves to be held prisoner to the 1990s mystique of central bank independence.
Two new issues make this pivotal in the current moment. One is the financial legacy of the COVID-19 crisis, which will burden us with gigantic debts. The balance sheet of the central bank is a pivotal mechanism for managing those debts. The other issue is the green energy transition and the need to make our societies resilient to environmental shocks to come. That will require government spending but also a reorientation of private credit toward sustainable investments. In that process, the central bank also has a key role. The current mandates require those concerns to be shoehorned in by way of arguments about financial stability. It is time for a more direct and openly political approach.
The independence model emerged from the collapse of the Bretton Woods system and the need to anchor inflation during the Great Inflation of the 1970s. The huge range of interventions currently being pursued by global central banks have emerged out of the crises of a globally integrated financial system. They have been enabled by the absence of inflationary risk. They have succeeded in staving off catastrophe for now. But they lack a positive purpose and updated democratic grounding.
We value price stability, but for better and for worse the forces that once made it an urgent problem are no longer pressing. That objective alone is no longer sufficient to define the mandate of the most important economic policymaking agency. Financial stability is essential, but the current incestuous relationship between central banks and the financial system tends, if anything, to underwrite and encourage dangerous speculation by a self-enriching elite. Meanwhile, slow growth, inequality, and unemployment are at the root both of many of our social ills and by the same token the problem of the debt burden—how we manage government debt depends crucially on how rapidly the economy is growing. Finally, we can no longer deny that we confront fundamental environmental issues that pose a dramatic generational challenge for investment.
These are the policy challenges of the third decade of the 21st century. Money and finance must play a key role in addressing all of them. And central banks must therefore be at the heart of policymaking. To pretend otherwise is to deny both the logic of economics and the actual developments in central banking of recent decades. We should also acknowledge however that this expansion stands in tension with the current political construction of central banks and particularly the ECB. Defining their position in terms of independence, strictly delimited mandates, and rules limits their democratic accountability. That was the explicit intention of the conservative reaction to the turmoil of the 1970s.
If Europe wants to escape the impasse created by the German court ruling, in which one countermajoritarian institution checks another at the behest of a resentful and self-interested minority, we need to step out from this historical shadow. Doing so is no doubt hedged with risks. But so too is attempting to patch and mend our anachronistic status quo. Half a century on from the collapse of Bretton Woods and the emergence of a fiat money world, 20 years since the beginning of the euro, it is time to give our financial and monetary system a new constitutional purpose. In so doing, Europe would not only be laying to rest its own inner demons. It would offer a model for the rest of the world." - Adam Tooze, foreignpolicy.com, 13 May 2020