Central banks should think about their function

The annual central bankers’ conference in Jackson Hole will be upon us tomorrow, and Fed Chair Yellen and ECB President Draghi are both taking part. Any great expectations look set to be dashed, and no notable news looks to be on the cards. Instead, the central bank presidents will presumably explain the political line taken to date, without giving any new impulses.

In terms of monetary policy, the central bankers currently face the problem that they lack a cause for reducing the monetary policy stimulus the way they want. Because inflation, the most important target variable in monetary policy, has not reached the target level postulated.

It’s hard to explain the current development in terms of the standard model for the industrialised nations’ economies. This is probably also a sign that the economic structure is subject to a very fast speed of change. This in part washes away the theoretical foundations for monetary policy’s thrust.

The long phase of extremely expansionary monetary policy has sparked debate on the sheer power that central banks wield. The impact it has on real policymaking gives rise to the question whether an institution that has not been democratically elected and is also not subject to any democratic controls should be allowed to have so much political and economic influence. It seems that a new mandate for them is in order.

Structural changes should also impact on central banks. For example, the process of payment transactions is changing fast. The traditional task of interest-rate management could be achieved indirectly by means of control of the money supply. This would of course require a well-structured and meaningful regulatory regime for banks, but need not necessarily be the remit of central Banks.

The financial markets, the banks, and the regulatory regime are subject to sharp change. It is now time to start thinking about the future role of one of the main actors, namely the central banks. There should be no holds barred in debates that focus once again on the real duties of central banks, just as there were not when it came to expanding the measures by central banks.

The end of the week will see the annual meeting of central bank presidents in Jackson Hole. This year, Fed Chair Yellen and ECB President Draghi will again take part. Although the conference attracts a lot of attention world-wide, no notable news looks to be on the cards. Instead, the central bank presidents will presumably explain the political line taken to date, but not give any new impulses.

That said, there is much for the central banks to discuss. For international monetary policy faces a growing dilemma. There can be no doubting that with their robust interventions in 2008 and 2009, the central banks prevented the global economy from melt-down. Thereafter, monetary policy became extreme. Interest rates were lowered to zero percent or even less. And additionally the central banks started buying bonds and thus lowering yields in a controlled fashion. These massive monetary policy stimuli led to global growth steadying and helped drive the long-standing boom in the equity and bond markets.

Now the central banks face the problem that there is actually no cause to reduce the monetary policy stimulus. Because inflation, the most important monetary policy target variable, has not reached the level targeted. In the logic of the central banks there are therefore few reasons to scale back the monetary policy measures as normative arguments hardly count in such a context.

The problem of low wage increases, which primarily cause the low inflation, has become so acute that ECB representatives have already caused for sharper wage increases. It must be said, however, that formulating wage policy is most certainly not one of the tasks of a central bank. However, the German Ministry of Economic Affairs has also complained of wage trends being only modest and encouraged more growth in wages, although this demand should be seen in the context of the current election campaign.

All in all, one could be forgiven for increasingly thinking that central banks have forfeited some of their target functions. Ultimately, it is hard to explain the current development in terms of the standard model for the industrialised nations’ economies. This is probably also a sign that the economic structure is subject to a very fast speed of structural change. This in part washes away the theoretical foundations for monetary policy’s thrust.

Alongside the problems that relate purely to monetary policy, a debate relating to central bank policy has arisen as regards the sheer power of the central banks. In particular, the bond purchasing programmes can have massive political influence as they lower governments’ refinancing costs and thus help drive a huge redistribution of wealth from the private to the public sector. In a system of independent central banks, this can be achieved without any major loss in central bank credibility. However, it does broach the question whether an institution that was not democratically elected and is not subject to any democratic controls should be allowed so much political influence.

The central banks should concentrate more strongly on their core duties. This is especially true of the ECB, which given the striking structural differences within the Eurozone through its measures is increasingly creating economic policy stimuli. There should be no holds barred in debates that focus once again on the real duties of central banks, just as there were not when it came to expanding the measures by central banks.

The development of the Bitcoin shows that a currency can exist without a bank of reserve behind it, although it is at present highly volatile. Moreover, the payment transactions process is itself in the throes of change. Internet-based payments systems such as Apple Pay or Google Pay, just like the development of “instant payment” where sums of money are booked in real time, will presumably significantly change the current system of bank-based payment transactions in the years ahead.

These structural changes will probably impact on the central banks. And one can also ask the provocative question whether it should in fact be central banks that set interest rates, or whether this could be left to the banks and the markets. Interest-rate management could instead be achieved indirectly by means of control of the money supply. This would of course require a well-structured and meaningful regulatory regime for banks, but need not necessarily be the remit of central banks.

The financial markets, the banks, and the regulatory regime are subject to sharp change. It is now time to start thinking about the future role of one of the main actors, namely the central banks. It is very doubtful whether it suffices simply to discuss a new definition of inflation targets. Instead fundamental mandates and functions now need to be defined for the future.

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