Op-ed: With a New Role to Play, Central Bankers Will Not Be Retreating to the Wings
29 NOV 2016 -- The following op-ed was published today by Huw Pill, chief European economist at Goldman Sachs, in The Times (London):
At the peak of the financial crisis, easy monetary policy sustained aggregate demand, as fiscal consolidation was needed to preserve the credibility of public finances. Yet, with interest rates at very low levels and the adverse side effects of unconventional measures becoming evident, now, should the economy falter, the scope for further monetary easing appears limited.
Time, then, to pass the baton to fiscal policy. With yields still close to historically low levels, government borrowing to fund much-needed infrastructure not only serves to bolster demand in uncertain times, but also strengthens the economy's supply side. Philip Hammond's autumn statement last week revealed an additional £23 billion of public investment in the UK. More broadly, forecasts published by the Office for Budget Responsibility anticipate UK public borrowing to be £122 billion higher over the next five years than was expected in March.
Given this change of focus, is the importance (and media visibility) of central bankers set to wane as fiscal policy replaces monetary policy in providing macroeconomic stimulus? There are reasons to think not.
First, since the financial crisis, central banks have assumed additional roles beyond monetary policy. New macroprudential instruments (such as bank stress tests) seek to dampen the credit cycle and improve the resilience of the financial sector. The redesign of international financial regulation continues. The Bank of England has reassumed responsibility for supervising the banking system.
Each of these policy domains is important in its own right.
Collectively they interact with each other and with traditional fiscal and monetary tools. As Mark Carney at the Bank of England emphasised over the summer, an internally consistent policy package encompassing all components is needed. Central banks will be at the heart of designing that package.
Second, fiscal and monetary policies have become closely entwined. With interest rates at close to zero and QE in place, the distinction between monetary and fiscal measures has blurred. In particular, governments' ability to ease fiscal policy is supported by the creation of "fiscal space" on their balance sheets via central bank purchases of sovereign debt.
The Bank of England bought £375 billion of gilts in the early phases of its quantitative easing programme. More immediately, in the face of the £122 billion additional gilt issuance forecast by the OBR after Brexit, the Bank has already announced new QE purchases of £60billion. Without this support, the chancellor's room for manoeuvre would be more limited.
Central bankers therefore remain central to the macroeconomic debate, even as the baton is passed from monetary to fiscal policy. But their role is changing. As central banks assume new responsibilities, they engage in more controversial issues. Central bank independence was born of a "social contract" between monetary technocrats and the wider society that they serve. The latter were prepared to delegate considerable autonomy to the former for the pursuit of a narrowly defined objective (price stability) with specific policy tools (interest rates). In many eyes, this proved successful prior to the crisis.
Now that central banks have wider responsibilities and a broader set of instruments, that social contract is up for renegotiation. As Mark Carney has found with his interventions on the Scottish and Brexit referendums, central bankers claiming the prerogative of independence over broader issues and mandates do so at their own peril, a peril that may weaken the necessary independence and legitimacy of their pursuit of their inflation target.
Creating and institutionalising a new social contract between central banks and society more appropriate to today is necessary if the hard-won traditional benefits of central bank independence are to be preserved.