Are Modern Central Banks too Powerful for their Own Good? A Political Economy Approach to the Desirability and Limits of All-Powerful Central Banks

Abstract

The aim of this article is to examine the level of power enjoyed nowadays by central banks. In a first section I go through the different sources of this power, analyzing their evolution during the first decade following the 2008 global financial crisis. A second section assesses the pros and cons of this new status. Finally, I conclude by offering a political economic account of the overall desirability underpinning the choice of having extremely powerful central banks, a pattern that has been reaffirmed in the 2020 global COVID crisis.

Keywords:

• central banks
• economic crisis
• governance
• regulation
• inflation targeting

JEL Classification Codes:

• E58
• E42
• E52
• B22
• P0
• F42

Notes

1 Alan Blinder (1998) welcomes the fact that the goals established by legislators “are sufficiently imprecise that they require considerable interpretation by the central bank” which, in turn, has “freedom to decide how to pursue” (54) them.

2 Or at least two: described, ex-post, in the general terms “lean or clean” (White 2009).

3 Howard Davies (2010) explains that “the behavior of central banks during this period was grounded in the belief that the appropriate role for the monetary authority was to control short-term inflation in consumer prices,” graciously neglecting “growth of credit and behavior of asset prices” (214).

4 John Williamson, who became especially famous—or infamous, depending on the circles—for coining the term Washington Consensus, explicitly supported this idea as we read in Williamson (2006).

5 Indeed, times of crisis and panic call for state intervention, which, in turn, increases state exposure to risk while remediating market mismanagement. Accordingly, the Fed itself was created “after the Panic of 1907 with broad authority and a range of instruments to assume precisely this type of risk” (Geithner 2008). However, as Howard Davies and David Green (2010) explain, “for the most part,” central banks’ “involvement has developed in an unplanned way” (110).

6 To be just, in fact a fair amount of people within central banks were worried. However, they opted not to act.

7 The NICE decade as Mervyn King (2003) stated.

8 For example, through co-ordination with fiscal policy as J. Bradford DeLong and Lawrence Summers (2012) preach.

9 Arguably “modern independent central banks, most notably the ECB, have a higher degree of operational independence than virtually any other agency to which the state has delegated some of its responsibilities” (Buiter 2007).

10 Even if, as Davies and Green (2010) remind us, it was not “historically linked to an inflation targeting” (141) one should feel comfortable with the idea that independence, especially in the final decades of the twentieth century, was promoted as a prescribed remedy to inflationary tendencies in different countries. Distinctly, in the developing world, fostering central bank independence was perceived as a must do in order to gain credibility about the country’s commitment to stability.

11 Given that “the optimal monetary policy is not time-consistent” (Buiter 2007).

12 There is, in Davies and Green (2010, chapter 4), a comprehensive account of all different measures. Of special interest are Bank of England 2008, Financial Services Authority (FSA) 2008, BIS 2009, and Turner 2009.

13 The Bank of England maintains in its webpage a comprehensive account of this practice. Although it is the solution at hand, the bank recognizes that “standard economic models are of limited use in these unusual circumstances, and the empirical evidence is extremely limited” for one to be extremely assured about the consequences of this practice. The hope, however, is that it will be able to “boost spending” and soon allow an “exit strategy” from this unconventional behavior.

14 That is especially true when we put it in perspective. As Harold James (2010) reminds us “before the 20th century, central banks were more concerned with the management of government debt and with financial stability.”

15 In this regard, alternatives as the one expressed by Frances Coppola (2019) should come to the table and be judiciously considered.

16 So spoke the Corinthians about the Corcyraeans before the assembly that was set up in Athens.

17 See Lagarde’s speech in January 2021.

Additional information

Notes on contributors

Henrique Estides Delgado

Henrique Estides Delgado is in the Josef Korbel School of International Studies at the University of Denver in Colorado and in the Department of Economics at the University of Chieti-Pescara in Italy.