Reflections on Central Banks

Contributed by: Ishwar Chidambaram, CFA

Contemporary central banks in the developed economies have triggered a global pandemic of moral hazard and Too Big To Fail problems. Ensconced as the universal lenders of last resort, their modus operandi has been to engage in laissez-faire economics during economic expansions and active intervention during a recession/contraction. Thus they have succeeded in privatizing gains and socializing losses, benefiting the elite 1% on Wall Street at the expense of Main Street.

Nowhere was this more evident than during the Great Recession of 2008-09, when Wall Street banks annihilated $15 Trillion worth of global asset values, and were rewarded with government bailouts and golden parachutes, instead of jail time. Since 2008, the function of many central banks has been to act as cheerleaders for their nations’ stock markets, printing increasingly bewildering amounts of fiat currency, propping up share prices and committing other acts of financial harakiri. Not content with reducing interest rates to zero, many Central Banks in the developed world have resorted to penalizing savers by levying negative interest rates, as is the case in Sweden, Eurozone, Japan, etc. Currently almost half of Eurozone sovereign debt is trading with a negative yield!

Clearly these sordid sagas have highlighted the imperative for greater regulation of the Central Banks. One option could be to set up a global watchdog of Central Banks- along the lines of the Bank of International Settlements (BIS)- whose sole purpose would be oversight of global central banks. The road to hell is often paved with good intentions, however, and any such effort at setting up a global regulator can get stymied by the sheer amount of bureaucracy involved. Alternatively, the case can be made for increased government regulation of central banks. But then monetary policy will cease to be truly independent of the whims and fancies of the government of the day.

Ultimately there is no substitute for self-regulation, and central banks would be better off putting their own house in order. Politics must not interfere with working of the CBs, and governments (especially those in banana republics) must resist the temptation to appoint political stooges to critical positions in Central Banks. A committee of independent experts can be viewed as a means to ensure true monetary policy independence. While the US has the FOMC, India has also shown the way in this regard, with the RBI’s Monetary Policy Committee, responsible for framing monetary policy. This ensures true independence and autonomy of monetary policy.

To be truly free of political pressure, a system of checks and balances ought to be established. But as the saying goes: ‘Caesar’s wife must be above suspicion’, so a committee of external auditors should regularly appraise the independence of the Central Bank. This committee could report its findings to an independent regulatory ombudsman, established specifically for the purpose of ensuring Central Bank autonomy. Of course, every chain is only as strong as its weakest link, so the system suggested above is not entirely fool-proof and further refinements are in order. Cleaning the Augean stables of Central Banks is a Herculean task and not likely to be accomplished overnight. But well begun is half done, and it is important to take the necessary steps in the right direction.


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