Implementing monetary policy
How did Central Bankers get to be so powerful? Today, Central bankers have power over one of the most important economic policy spheres in a modern-day economy – i.e. monetary policy (usually in the form of interest rates).
However, this was not always the case. During the 1980s this power was transferred to Central Bankers in the guise of inflation-fighting. This transfer of power was due to the apparent inability, irresponsibility, and/or untrustworthiness of governments to take the necessary steps to control inflation.
To placate those concerned at the time at the apparent loss of democratic control over a core area of policy, there was reassurance from the ‘rules versus discretion’ literature. That is, there was no handover of policy power, just the handover of the implementation of a fixed ‘rule’ (i.e. loosen monetary policy if inflation is low; tighten monetary policy if inflation is high). Indeed, this was an acclaimed virtue of the move.
The simplicity of a ‘single target, single tool’ framework, meant the implementation of monetary policy could be transferred to a team of technocrats (i.e. Central Bank officials). Moreover, such technocrats would be immune to pesky external influences. Consequently, if any discretion was to be exercised then that would only be at the behest of Government. So, there was no loss of democratic accountability, choice or control.
The power grab
But, some three decades later, this argument is negated through the Central Bankers own admissions. An example is the recent speech by the Governor of the Reserve Bank of
New Zealand -
Monetary policy decisions are influenced by assessments of such questions based on research, modelling and scenario analysis. The complexity of the discussions that underlie policy decisions within a central bank belies the apparent simplicity of what is often a single interest rate instrument and a single inflation target.
In the end, judgement is inevitably involved in balancing a range of risks and uncertainties. Some of these lie beyond the influence of the central bank, while others can be addressed or moderated through monetary policy. Policy decisions inevitably involve reflection and pragmatism in managing different trade-offs.
And there you have it. The Central Bank does not impose a ‘rule’. Rather, it exercises judgement. And that admission, to me, is more than a bit breath-taking.
Judgement decisions on what economic policy should, or should not, be implemented lies rightly in the hands of the elected government. Government is the institution that is accountable to the people. Government is the only institution that has the mandate to make judgements as to which policy should, or should not, be implemented.
This distinction is not academic. It is critically important because judgement decisions are about trade-offs, as is clearly articulated in the Governor’s speech. And trade-offs inevitably result in some winners and some losers. That is the very nature of a trade-off.
I would argue strongly – nay, vehemently – that policy trade-off decisions should be clearly in the hands of our elected representatives. I want them to justify their decided choice of winners and losers, and have the opportunity to dismiss them if I disagree with their choices. That is the very nature of democracy.
Call me naïve if you must; but I do not remember handing over my right to influence the division of society between winners and losers to a group of technocrats. Definitely not to a group of bankers.
Bluntly, policy trade-off decisions should not be in the hands of technocrats, unelected officials, or – least of all – in the hands of a group of bankers
How did we get here?
Effectively, over the last three decades there has been considerable mission creep for the monetary policy framework. We started with an agreed target based on a ‘rule’, which limited discretion. But the original agreement to contract-out the implementation of monetary policy to a group of technocrats has been unilaterally re-written.
In essence, Central Banks have consolidated and expanded their powers so that they now include discretionary decisions as a ‘natural’ component of their function. There is now an entrenched acceptance that Central Bank power is the norm in the management of any economy.
Further, many governments around the world have been keen to accommodate this breach of contract in order to fulfil their desire to limit government discretionary intervention; while other governments have just remained either blind and culpably neglectful to this consolidation of power.
What needs to happen?
There needs to be a brake, and then a reversal, on the expansion of power and influence of Central Banks. They need to be reminded of their subservient status. Central Banks serve the economy; not the other way around. Central Banks should not be seen as ‘all powerful’. Rather, their role of implementing the policy decisions of Government needs to be re-established.
However, this also needs Government to step up to its role and responsibilities. Central Banks are not responsible for managing an economy; they are not responsible for ensuring sufficient housing supply to provide shelter for the populace; they are not responsible for ensuring wage levels are sufficient to live on; nor are they responsible for avoiding the next economic recession.
These are all the role and responsibility of Government. Government just need to stop contracting out their policy-setting role and to stop neglecting their responsibilities.