Ryan Avent on the Thirteen False Theses of the Bank for International Settlements, and Its Strange Demand that the World's Central Banks Push Unemployment Higher
Ryan Avent: Central banks: The twilight of the central banker:
The misjudgments common to central bankers are occasionally distilled in BIS analysis into a somewhat curious view of the global economy: one in which heroic, blameless central banks have done their utmost to keep the world economy afloat, in the face of ceaseless governmental incompetence and despite a constant bombardment of baseless outsider criticism. The ability of central bankers to bandage over the harm inflicted by bumbling politicians is limited, warns the BIS in its latest annual report. Unless the world embraces the sober leadership of the wise central banker disaster looms.
The annual report is a remarkable document, one which might well come to serve as the epitaph for an era of central banking spanning the Volcker disinflation and the Great Recession—the epoch of the central banker as oracle, guru, maestro…. The report captures what may be the most critical error of the modern central banker: eschewing a focus on his proper domain—demand stabilisation—in favour of an arena in which he has no business sticking his nose—the economy's supply side.
Briefly, a dime summary of the report. Nearly half a decade on from the financial crisis, many troubling weaknesses in the global economy remain unaddressed. Deleveraging is occuring dreadfully slowly in many rich countries. "Imbalances" have scarcely been diminished. Monetary policy has propped up economic growth, temporarily buying time for broader structural reforms that governments have failed to deliver. The scope for central banks to do more is limited and the risks of further action are rising. Meanwhile, government debt is a huge threat….
The overarching theme… central banks have done what the economic situation has called for and then some, and they should not and cannot be expected to do much more… other economic policymakers must finally heed central bankers' recommendations for how to clean up their messes, fiscal, structural, and otherwise. It strikes me as a deeply mistaken view of the state of the world economy and the proper role of the central banker.
At the heart of the BIS' flawed thinking are a number of key misconceptions:
Low interest rates represent accommodative monetary policy. This is a venerable error, also popular during the 1930s….
"Imbalances" take the onus of macroeconomic stabilisation off central banks. The BIS indulges in this misconception in two ways. First, it deploys the balance-sheet recession argument that overindebted consumers and firms are immune to low interest rates. This is obviously true of many households and businesses but clearly isn't true of all of them. The job of monetary policy is set the policy rate such that cash-flush entities pick up the slack from those paying down their debts. Central banks are there to clear the market, and the statement that there is excess saving in an economy is equivalent to the statement that policy is too tight….
The BIS takes the distressingly Hayekian (or Mellonist) view that "malinvestment" during the boom must somehow be paid for in slower growth now…. The BIS cites imbalances as obstacles to effective monetary policy while acknowledging that by pushing unconventional monetary policy further central banks can impact aggregate demand. A host of accompanying risks to such policy suggests they should not, however. What sort of risks?…
"Prolonged unusually accommodative monetary conditions mask underlying balance sheet problems and reduce incentives to address them head-on. Necessary fiscal consolidation and structural reform to restore fiscal sustainability could be delayed." If the central bank does its job, in other words, politicians may not do the things central bankers think they ought to do. Implied in this assessment is that it is the central banker's job to hold elected governments accountable for public finances and supply-side policies rather than the electorate's. This represents both a dereliction of the central bank's duty and an astounding policy overreach….
"[L]arge-scale asset purchases and unconditional liquidity support together with very low interest rates can undermine the perceived need to deal with banks' impaired assets." In other words, neglect of the central bank's primary duty may be appropriate in order to focus the minds of bank executives and politicians on potential asset losses. Translated, this is effectively the liquidationist view of recovery; if interest rates were higher, advanced economies would be forced into wholesale default, the end result of which would be (assuming society survives the ensuing depression) clean balance sheets.
Other risks of low rates include lower returns for banks and large institutional investors, which may in turn be encouraged to take more risk. Of course, a very low natural rate of interest is the result of excess saving; the central bank's goal is to move its policy rate toward the natural rate in order to mobilise that saving and clear markets. These "risks" are symptomatic of the broader macroeconomic situation and of appropriate central bank efforts to rectify it. True, "financial vulnerabilities" or excesses could result from low rates, but interest-rate policy is an extraordinarily blunt and costly way to rule out such threats, essentially amounting to engineered recession in order to prevent bubbles. Better to use central banks' ample regulatory tools.
Strikingly, the BIS also frets about emerging-market spillovers from rich-world monetary policy…. Inasmuch as China has acted as their conduit… spillovers are a key means through which to address those feared imbalances. Chinese inflation has facilitated a real exchange rate adjustment which is chipping away at its chronic current-account surplus and others' chronic deficits….
The BIS also says: "Loose global monetary policy has probably also contributed to the strength of commodity prices since 2009...Commodity prices are set in global auction markets and are very sensitive to global demand conditions, which are in turn shaped by the global monetary policy stance." This is a nice echo of its exhortation in last year's report that global economic growth must slow. Prices for scarce commodities can't be allowed to clear markets, suggests the BIS. Central bankers should instead engineer a global demand shortfall in order to keep them in check….
Regrettably absent… is any attempt at an actual cost-benefit calculation. The BIS seems to acknowledge that central banks remain able to boost aggregate demand. They should not do much more, it is argued, because of the above risks. There are substantial risks to not doing more, however, the most significant of which are the enormous costs of prolonged high unemployment and the eventual structural impairment of an economy suffering from a chronic output gap. One could easily begin with the proposition that central banks aren't out of firepower and craft an entire report on the massive risks of large, persistent output gaps, which demand an overwhelming central-bank response. The BIS behaves as if this dynamic doesn't exist.
Something something fiscal policy. Central bankers have strong views on what governments ought to be doing with their budgets, many of which make most sense when given the least scrutiny…. The BIS fails to wrestle with the fact that borrowing costs for sovereigns without central banks have risen while those elsewhere have not; it finds itself relying on discredited ratings agencies for assessments of non-euro-zone sovereign creditworthiness rather than market prices. The BIS also dances around a parallel, uncomfortable fact: that austerity within the euro-zone has often enough been associated with falling market confidence and not the other way around…. Over the short- to medium-term, which is the central bank's arena, the story the BIS would like to tell falls apart amid complicating factors. The central bank's best approach is to do its job and let markets and voters hold governments accountable.
Attention is paid in the report to the problem of a safe-asset shortage, but here, too, the recommended action is too simplistic by far. The way to solve the safe-asset problem, the BIS suggests, is through broad austerity sufficient to return many sovereigns to creditworthiness…. But it's also critical to recognise that creditworthiness alone is not sufficient to make an asset safe. Market size and liquidity also matter…. And here is the rub, a version of the Triffin dilemma: if those countries begin pursuing austerity they will restrict the supply of new, safe debt, thereby exacerbating the safe-asset shortage. Of course, if they move in the other direction and rapidly raise their annual borrowing, a marginal subset of these economies could move from safe to unsafe status. The broader point is that worldwide fiscal consolidation is not obviously the right choice, and that these fiscal questions are generally more complicated than the BIS lets on.
And then there is this chestnut: "It would be a mistake to think that central bankers can use their balance sheets to solve every economic and financial problem: they cannot induce deleveraging, they cannot correct sectoral imbalances, and they cannot address solvency problems." This is problematic across the board, but let's just focus on the last bit. Solvency, it is very important to remember, is state-contingent. In a protracted liquidity crisis, the solvent become insolvent. If central banks begin holding nominal growth at levels well below those expected when large debts were incurred, borrowers with a reasonable expectation of solvency ex ante will find themselves insolvent ex post. A central bank is not reponsible for solvency problems that emerge while it keeps to an expected, stable demand path. It does bear responsibility for insolvency that emerges as a result of persistent, preventable demand shortfalls…. It is entirely understandable that central banks maintain a close interest in fiscal policy. Central bankers would always prefer not to act, and fiscal mismanagement may force them to take corrective steps. That's life, however; the job of the central banker is not to make the central banker feel comfortable….
The BIS…. "Although central banks in many advanced economies may have no choice but to keep monetary policy relatively accommodative for now, they should use every opportunity to raise the pressure for deleveraging, balance sheet repair and structural adjustment by other means." No. They should not. Central banks—small, elite, technocratic groups given as much independence from political pressure as is institutionally possible—should absolutely not use every opportunity to raise the pressure for structural adjustment. Central bankers have been given a phenomenal amount of economic power: relatively untrammeled control over the unit of exchange and, by extension, over the demand side of the economy. Use of that phenomenal power to influence control over other aspects of the economy—including budget decisions, labour-market regulations, and the benefit structure of old-age pensions—is wildly outside the purview of the central bank and sure to prove corrosive to the independence of the central bank and the democratic process. Central bankers will inevitably face limits on what they can achieve…. For a central bank to neglect its primary responsibilities in an effort to circumvent those limits is the height of folly and hubris. If the world is lucky, central bankers will discount the recommendations of the BIS…. If the world is unlucky, central bankers will embrace the BIS' excuse-making and opt instead to place unnecessary pressure on politicians that are already facing plenty of it. In that event, tough times indeed are ahead, the advent of which may usher in a regime change in thinking about central bank structure, governance, and policy.
