New masters of the universe sound like the title for the next Marvel Hollywood blockbuster but when we apply this phrase to the suit-wearing community of central bankers, we are only exaggerating a little!
Politicians, as we know, thrive on the attention of media and positively court publicity. Mark Carney the Canadian former Governor of the Bank of England was perhaps the closest we’ve had to a politician in this regard. The normal and time-honoured way of it for central bankers is to work behind the scenes and to remain distinctly unobtrusive. However, the real terms power wielded by central banks is genuinely colossal and their utterances and reports are scrutinised line-by-line and often even between the lines.
Central banks really do need to be independent of politicians and this is the case in the lion’s share of countries around the world. This is even more important when the country in question operates its own fiat currency such as the US dollar or the pound sterling. When the roles of politicians and central bankers get confused and overlap problems can occur. For example, in the 1970s politicians instructed central banks to print money to fund projects and to avoid raising taxes. This coupled with surging oil prices delivered the unfortunate side effect of runaway inflation, which is quite possibly the most destructive “money disease”.
There are no perfect solutions, only trade-offs -Thomas Sewell
Central banks have certainly saved the day, economically speaking, during the pandemic and have undoubtedly performed an essential role with aplomb. Learning from possible mistakes made during the Great Financial Crisis of 2008/9 central banks led by the most powerful Federal Reserve in the United States “went bigger and faster” than before by printing money and pouring liquidity into the economy. Of course, this helped to save businesses and preserve jobs until the worst impacts of Covid-19 began to subside. These interventions saved the global economy, but the positive overall impact of this economic medicine does not come without side effects and trade-offs.
Printing money in ever-larger quantities to purchase government bonds and thus funding government spending can to some blur the lines between essential independence and political behaviour. Central banks insist they are not “monetising the deficit”, a phrase that provokes professional investors to bring out the garlic and crucifixes. A Financial Times survey of investment managers found in January that this is what many believe is happening. Others point to the economic policies of Modern Monetary Theory [explained beautifully in an article written by our chairman earlier this year]. In any event, inflation has spiked up noticeably and we all feel the impact.
Another trade-off for central bank activity is to stimulate demand for, and price rises in risk assets. Despite the pandemic house prices have boomed, equity valuations have reached super-normal levels. Of course, when central banks buy government bonds yields fall and capital values rise. This so-called financial repression punishes cash investors and typically boosts portfolio valuations of wealthier folk and more savvy investors. Lower bond yields allow for higher equity valuations but can leave some investors fixated purely on fundamentals scratching their heads vigorously.
In most major developed economies central banks operate with a clear mandate – Since 1977, the Federal Reserve has operated under a mandate from Congress to "promote effectively the goals of maximum employment, stable prices, and moderate long term interest rates". Stable prices have more recently been defined as an average inflation figure of 2%. US inflation is running at more than 5% presently and we all hope the Federal Reserve is right in its assessment of the transitory nature of current price rises, otherwise interest rates will need to rise.
So how can we square the circle?
It is probably wrong for total economic power to reside with unelected central banking technocrats, but it is certainly the case that where central banks perform the role of a marionette to politicians is also a dangerous scenario. Providing a balanced approach with independent oversight seems to be one way forward.
As the economist, Thomas Sewell noted, “there are no perfect solutions, only trade-offs.”