Central bankers are engaged in the most sweeping rethink of their role in decades, spurred by the success of tight collaboration with governments in countering the pandemic crisis and a new political reality of increased demands on monetary policy makers.
The Federal Reserve, European Central Bank and emerging market counterparts like Bank Indonesia are among those that enabled fiscal authorities to ramp up emergency spending without driving borrowing costs up, through large-scale bond purchases.
As the crisis recedes, many policy makers favor keeping their expanded role in shaping economies and even broadening it further -- to incorporate social goals such as climate change and curbing inequality. The new pact has been enabled by sustained low inflation in recent years, any change to which could again shift policy makers’ views.
As governments expand social safety nets, the growing public debt loads will make it challenging for central banks to shrink their balance sheets or attempt to return interest rates to pre-crisis levels.
The new approach in one sense takes central banks back to their original mission more than a century ago, which focused more on the economy than on consumer prices.
New Mission
Rising share of central bank speeches mentioning inequality
Bank for International Settlements, Deutsche Bank AG
“We are very far removed from the political economy of the 1980s and 1990s that prized delegating power to central bankers to quash inflation,” said Sarah Binder, a senior fellow at the Brookings Institution. “In the wake of the financial crisis and pandemic, and political demands for more activist central banks, they have returned to their roots -- fighting crises and helping to restore economic growth.”
Benefits from more active central banks could include higher sustained employment over time, along with greater progress on nurturing green finance. But some caution that a greater political role could make it harder for monetary policy makers to tighten their stance in the face of escalating inflation or asset-bubble risks.
For now, central bankers seem happy about their partnership with big-spending governments and broadened objectives. Deutsche Bank AG analysts note a jump in mentions of “inequality” in speeches by central bankers, a shift from their previous focus on inflation.
“Recent years have seen central banks increasingly enter the debate on numerous other topics including fiscal policy, social justice, race, gender issues, climate change and inequality,” Deutsche Bank analysts wrote earlier this week. “It does show how central bank power and influence has changed and also how they seem to be giving governments cover to spend on these issues.”
Expansive ECB
In the euro zone, the ECB on Thursday joined the Fed and BOJ in tweaking its policy to provide for an overshooting of its inflation target for a time. It also incorporated climate change into its policy framework, days before the BOJ is set to unveil a climate-focused lending initiative.
ECB President Christine Lagarde has lauded the symbiotic relationship between monetary and fiscal policy during the crisis, as the 19 governments in the currency bloc spent record sums on protecting companies and workers from the pandemic fallout.
Fed Chair Jerome Powell also was a reliable advocate for U.S. lawmakers who wanted to ramp up fiscal aid during the pandemic. Borrowing costs were held down even as the government deployed an unprecedented scale of emergency spending, thanks to the Fed’s mammoth asset purchases.
The Fed’s 2020 emergency credit programs reached far beyond the bank and market support of the 2008 crisis and were extended to municipalities, large corporations, and even Main Street businesses.
‘Tenuous’ Endgame
Taimur Baig, the Singapore-based chief economist at DBS Bank Ltd. who previously worked at the International Monetary Fund, said there is scope for central banks to do more on a continuing basis. There’s logic in looking at climate change, given that it does have a financial stability element, he said.
But Baig worries about what happens when it comes time to wind back the pandemic-era monetary largesse.
“The exit or endgame looks rather tenuous,” said Baig, who also previously served at the Monetary Authority of Singapore. As central banks move “deeper into the fiscal sphere,” there’s the risk that they become “paralyzed if they fear market and political repercussions from selling bonds,” he said.
Not all central banks have embraced new roles. Those in Mexico and Brazil didn’t mount the type of extraordinary asset purchases during the pandemic seen elsewhere, for example. And some have already raised interest rates to address inflation risks.
Political Pressure
But political interests are coming to bear in some locations nonetheless.
Mexico’s President Andres Manuel Lopez Obrador ruled out a second term for central bank Governor Alejandro Diaz de Leon, saying he wanted an economist “with a social dimension -- one who is in favor of a moral economy.”
After the Bank of Korea made preparations to raise interest rates amid plans by South Korea’s government to keep fiscal stimulus rolling, Finance Minister Hong Nam-ki held an unusual meeting with Governor Lee Ju-yeol. The July 2 breakfast meeting produced an agreement that fiscal and monetary policies should complement each other, according to a joint statement.
Monetary authorities know they exist by political consensus. If the consensus is shifting, they have to be part of the dialogue or risk losing their jobs.
“There is always this challenge of striking the right balance between cooperation, coordination and lack of independence,” Bank of Thailand Governor Sethaput Suthiwartnarueput said in a June 24 interview.
‘Extraordinary Junction’
In Indonesia, President Joko Widodo said in an April interview that he supports legislation that would expand the central bank’s mandate to include job creation and sustainable economic growth.
The central bank already has demonstrated a role in longer-term growth even though it’s not part of its official mandate, Bank of Indonesia Governor Perry Warjiyo said in a briefing last month.
For all the leaning in to progressive agendas, Paul Tucker, a former deputy governor of the Bank of England, points out that it was high inflation that destroyed center-left governments politically in the past, and led to central bank independence in the first place.
It’s “been strange not to hear more about the priority of keeping longer term inflation expectations anchored whatever happens in the shorter-run, since that is the point of being independent from day-to-day politics,” said Tucker, now a senior fellow at Harvard University. Monetary-fiscal cooperation can’t come at the cost of “losing credibility for price stability and financial stability,” he said.
“We are certainly at an extraordinary junction” in central banking, Tucker concluded.
— With assistance by Alexander Weber, Sam Kim, Suttinee Yuvejwattana, and Yudith Ho
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