On Central Banks

One of the most remarkable (but so far least remarked upon) features of the ongoing financial crisis is the role which has been played by central banks. With governments either unwilling or unable to address the problems of the financial system through regulation and the problems of the wider economy through fiscal measures, responsibility for both mitigating the crisis and engineering the recovery has been quietly seized by central banks. 

The ECB has been credited with (if only temporarily) pulling the European banking system from the edge of collapse through the injection of over a billion of Euros of liquidity via the Long Term Refinancing Operation (LTRO). The Bank of England and U.S. Federal reserve have similarly been cast as heroes for their quantitative easing (QE) programmes – the Bank of England’s, which began in March 2009, has involved a commitment to £325 billion worth of asset purchases in an effort to ease credit creation in the banking system. The Fed’s successive QE programmes took the value of its holding s of Treasury Notes up from $800 billion pre-crisis to over $2 trillion in less than two years. Central bank balance sheets have grown explosively.

Via Financial Times

These actions are remarkable not simply because of the sums of money involved, but because of the divergence it marks from the script which central banks are supposed to follow in modern capitalism.

The script, written during the 1980s and implemented in the 1990s, in heavily truncated form goes roughly as follows: central banks operate primarily to safeguard monetary stability, targeting price inflation via control over short term interest rates. The economic importance of monetary stability is such that the central banks should be granted independence from political interference, and allowed to function as politically neutral technocracies acting in the general interest.

Central banks time honoured role in disaster control as a lender of last resort to commercial banks and a guardian of overall financial stability was considered to be obsolete given the advances in risk-reducing financial innovation. New institutions such as the Financial Services Authority in the UK were formed to unburden central banks of this regulatory duty. These new institutions addressed risk on the micro level of governance in individual firms, while both the Fed and the BoE drastically cut back on the attention devoted to systemic financial stability issues. Mervyn King’s disdain for the Financial Stability Committee made it a “running joke” within the BoE according to one insider quoted by the FT.

Events of the past four years have meant that the script has been thoroughly torn up: in an era of LTRO and QE central banks have a far wider range of duties and a wider range of tools with which to carry them out. By keeping a terminally ill banking system on life support and in the UK and EU providing backing for controversial austerity measures, they have become unaccountable political actors rather than neutral technocrats.

In a conjuncture which could be described as central bank led capitalism, ambiguity surrounds the issue of what central banks have become and what they should be, and a number of questions present themselves.

1)      Firstly, what function do central banks now perform? There is a need to address this simplest of questions on both a technical and a political-strategic level; the former because the operations of central banks, or at least the discourses used to articulate them, are esoteric, and the latter because in both the long and the short term, the end goals of recent central bank actions could be interpreted in a variety of ways.

2)       Secondly, how effective have the recent actions taken by central banks been? Or rather, if this is now a central bank led capitalism, how well are they able to lead? Popular representations of the central banks and central bankers of late have tended to present them as reluctant hero figures (e.g. Ben Bernanke as Time Magazine person of the year 2009) capable, to borrow David Cameron’s phrase, of wielding ‘the big bazooka’ and breaking the negative feedback loop of financial collapse once other measures have failed. Does this all powerful image fit reality?

3)      Thirdly, was ‘the script’ ever that useful a way of understanding central banks, or does the common historical account of their role and capabilities need a revision in light of recent events?

Over the coming weeks, this blog will make an attempt to address some of these questions by way of a dialogue.