Yearning for the central banks of yore

US Federal Reserve Chair Janet Yellen
US Federal Reserve Chair Janet Yellen

In the good old days, the role of a central bank was straightforward, clear-cut, one might even say, boring. Central bank independence meant that the super-bankers were to abstain from politics. Their job was predictable: to raise benchmark rates when inflation appeared on the horizon. If the economy started to slip, central banks lowered rates, writes Chief Economist, Swiss Federation of Small and Medium Enterprises Henrique Schneider.

All that went out of the window in 2008, or maybe even as early as in 2003. The then wizard at the monetary ship’s helm, Alan Greenspan, stopped using the Taylor rule. This stipulates that for each percentage point increase in inflation, the central bank should raise the nominal interest rate by more than one percentage point.

But when the financial crisis struck, the US Federal Reserve Board changed all the rules. And by doing so, it transformed the role of central banking worldwide. Central banks became wheeler-dealers of fiscal policy, super-investors and dominant market agents. They crowded out the genuine political decision-making of democratically elected bodies, the risk-appropriate investment decisions made by genuine investors (i.e. private firms) and all responsibility taken by individual market actors (i.e. people like you and me.)

Central banks have become the sole, dominant agent in global financial markets. The valuation of so many asset classes is now determined by central bank policies that, in some cases, private investors cannot purchase an asset for a price they would normally pay. As a result, investors adapted their behaviour: instead of investing in the economy, they began to gamble on the next monetary policy move.

It is safe to say that the whole global financial system is worse off after its appropriation by central banks than if it had been allowed to have a crisis. The risks that have built up are massive:

Since 2008, the US Fed has purchased more than US$3.5 trillion of Treasury debt. The Bank of England accumulated 375 billion pounds (US$574 billion) in government-issued bonds. The Bank of Japan bought about 2.8 trillion yen (US$23 billion) in private debt. In January 2015, the European Central Bank started its ‘unorthodox’ quantitative easing programme to purchase at least 1.1 trillion euros (US$1.2 trillion) of government debt. (And keep in mind, some of these governments have a propensity for and recent history of default).

And the list goes on. The People’s Bank of China has poured an estimated 100 billion yuan (US$16.1 billion) into state-owned enterprises. Switzerland’s monetary base has quintupled since 2011. As of the end of 2014, the balance sheet of the Swiss National Bank was about US$500 billion, equivalent to 80 per cent of the country’s gross domestic product. That is three times bigger than the size of the US Fed’s or the BoE’s asset-buying programmes in relation to their economies.

At long last, the Fed is openly considering beginning to return to less madness in central banking. But after hijacking the markets, it is now being held hostage by those who are gambling on its future decisions. In the immortal words of the bard: ‘These late eclipses of the sun and moon portend no good to us.’

Related statements:

Scandalised and bored by the Greek saga

Secular stagnation must not be accepted


Add your comment