“The strongly increased risks of central banks may act as a constraint on the room for manoeuvre in future monetary policy.” That is the worst case scenario laid out by new research from the Bank of Finland. The thoughtful, comprehensive analysis of eight central banks looks at unconventional tools adopted during the crisis, concluding: “The actions by central banks during the crisis raise a number of questions concerning exit from the measures taken, the impact of the measures, central banks’ risks and independence and their governance structures.”
The turn of the year – and the final post on this blog for 2010 – make a summary of this paper seem appropriate. Which of the unconventional tools – if any – will be discarded in 2011?
The IMF has tried to rally the troops at a meeting in China, urging central bankers to maintain the international co-operation forged during the financial crisis, and looking to Asia to lead the way.
At an IMF-sponsored meeting of central bankers and regulatory luminaries in Shanghai, an “important consensus” was reached, according to PBoC deputy governor Yi Gang, on the need for international co-operation in ensuring strong macro-prudential policies, because systemic risks “are very likely to spread over borders.” In practice, this means central banks and national regulators taking on more international roles.
Central banks also need to take a broader view domestically, said IMF managing director Dominique Strauss Kahn, seeming to suggest that financial stability would be part of central banks’ remits going forward. “Clearly, conventional macroeconomic policies and macro-prudential tools are intrinsically linked, just as price stability and financial stability are intrinsically linked,” Strauss-Kahn said. “We need a holistic approach, which means a changing role for central banks in the years ahead.”
How is the European Central Bank judging the success of its eurozone government bond purchases? The programme. launched at the height of the eurozone debt crisis in May, has been particularly controversial in Germany, and Jean-Claude Trichet, ECB president, pointed out on Thursday that the scale of purchases – concentrated on the bonds of southern European countries – has been on a downward trend ever since it started.
Mr Trichet made the same point at the ”ECB watchers” conference in Frankfurt this morning (an annual get together in which ECB policymakers are put on the spot by analysts, bankers etc). To me, that suggested the ECB would love to be able to run the programme down even further, and could soon stop buying any bonds at all.
Ireland’s done it. The UK’s about to do it. Now Denmark’s quite keen too.
Central bank director Nils Bernstein has said he’d like to see much closer co-operation with the Danish regulator, the FSA. ‘We can see a trend in Europe and internationally which involves some kind of fusion between central banks and financial regulatory authorities,’ he told financial daily Børsen (Danish, translation). ‘This could be advantageous for Denmark too.’
“Monetary policy must be set in the light of the fiscal tightening over the coming years, the continuing fragility in financial markets and the state of the banking system,” Mervyn King said last night, offering a rare insight into the interplay between monetary and fiscal considerations at the Bank. The spirit of co-operation between Threadneedle Street and No 11 was also evident as Mr King welcomed Mr Osborne’s commitment to reduce the deficit.
Deficit cutting might harm growth, Mr King acknowledged implicitly: “If prospects for growth were to weaken, the outlook for inflation would probably be lower and monetary policy could then respond.” Quite what that response would look like – further cuts to the base rate or an increase in QE – was not clear.
Price stability is a function of two things: a central bank’s power to refuse to buy government bonds, and whether a governor can be fired (without cause). These two variables “have all the predictive power for inflation associated with central bank independence,” said the BoE’s Adam Posen in a characteristically punchy speech yesterday.
This simple formula is quite shocking. Many common indicators of independence are omitted. Central bank mandates have little explanatory power. Neither does a bank’s technical independence from the political process; legislation, after all, can be ignored or rewritten. Topically, a central bank’s purchase of government bonds has no impact on inflation, according to Mr Posen, as long as the purchase was voluntary. Indeed, more harm than good may come from a bank obstinately refusing to enter the fray
Price stability is no longer a sufficient target for central bank policy, according to South Korean central bank governor Kim Choong-soo. “Perceptions as to the desirable role of the central bank are now shifting greatly,” he said at a speech commemorating the 60th anniversary of the bank.
Changes ahead for the Bank include expanding its remit to include financial stability; fostering closer ties with other central banks; and calling in consultants to help with the restructure. A key task was to work out how the goal of financial stability would fit with the “prime” goal of price stability.
It is just a few days until Lucas Papademos steps down as the European Central Bank’s vice president, and the ECB is holding a conference in his honour in Frankfurt. Quiet and thoughtful by character, Mr Papademos has not had a high profile. But he has been active behind the scenes, especially in recent weeks as the eurozone has lurched from crisis to crisis. (The fact that many of the problems have been focused on his native Greece might explain his reticence.)
Mr Papademos has been responsible for financial stability issues. Only a few years ago, that meant working laboriously on “financial stability reports” which at the time attracted little attention, but in hindsight gave clues about the trouble brewing in financial markets. More recently, central bankers have been debating whether central banks should take greater responsibility for the stability of the financial system on top of fighting inflation.