In the US, two senior central bank officials recently stepped down after concerns were raised about their trading activities during the pandemic. Robert Kaplan, Chairman of the Federal Reserve Bank of Dallas, will step down next month, and Eric Rosengren, President of the Federal Reserve Bank of Boston, will step down at the end of September.
Both were actively involved in financial markets at the beginning of the year, and therefore stood personally to benefit when the Federal Reserve made the unprecedented decision to extend its asset purchasing programme (what most of you will know as quantitative easing) to a number of different markets. The Fed not only created new money to purchase long-dated government bonds, it also actively intervened in corporate, consumer, and municipal debt markets – effectively propping up thousands of private companies, many of which then provided bumper returns to their shareholders.
These unprecedented interventions have created unprecedented problems for central banks. The idea behind central bank independence is that there exists a natural long-term rate of interest—the rate at which supply and demand for money are in equilibrium, prices are stable, and full employment is maintained—and the job of central bankers is to ensure that short-term interest rates in the real economy hover around this natural interest rate. Independence was required because politicians would always be tempted to fiddle with the central bank interest rate around elections to create jobs and boost incomes, even if that meant pushing up inflation.
This perspective was always based on a fiction – there is no ‘natural’ long-term rate of interest. Economies are dynamic and complex systems: decisions made about interest rates today will affect macroeconomic outcomes in the economy tomorrow in a multitude of unpredictable ways. As banks are able to create new money through lending, there are no hard short-term limits on the supply of money, so investment undertaken today will influence trends in employment, investment, and innovation that shape the way the economy works tomorrow.
As the political economist Benjamin Braun has argued, the problem with widespread asset purchasing programmes is that they undermine the fiction upon which central bank independence is based. When central banks started to buy long-dated government bonds, they revealed their intention to influence long-term interest rates, turning the long-term rate into a policy variable rather than a macroeconomic constant.
In other words, quantitative easing has proven that the decisions central banks make about monetary policy are political choices, not neutral technocratic judgements.
This point was made even more obvious when the Fed started to purchase private assets, like corporate bonds. The firms able to access this investment were able to borrow more cheaply. Many firms have taken advantage of the loose monetary conditions created by central banks either to engage in mergers and acquisitions, or simply to buy back their own shares or return money to shareholders.
The decisions made by many central banks around the world to flood their financial systems with cheap money have also raised asset prices in general. With interest rates low and safe assets like government bonds in short supply, investors have been ‘reaching for yield’ – buying up all sorts of assets in the hope of generating returns. The prices of everything from stocks to housing have therefore risen, creating massive capital gains for those who hold these assets.
Monetary policy is, in other words, not a simple technocratic exercise. Monetary policy is political. Central banks are making critical decisions about who gets what, without any democratic accountability. Monetary policy is now one of the most significant determinants of inequality and there are no mechanisms for the general public to influence how these decisions are being made.
This quandary is what has placed Kaplan and Rosengren in such hot water. If their job was simply to make sure short-term interest rates mirrored the imagined long-term natural rate, it would be much harder to accuse them of manipulating markets to suit their own interests. But if it is impossible to measure their performance against some long-term goal, then central bankers would be subject to an ever-present temptation to boost returns in financial markets to generate capital gains for themselves, even if doing so undermined financial stability over the long-run.
While the idea of market manipulation by Fed officials makes for good headlines, whether either man actively sought to influence Fed policy to promote their own returns is besides the point. In fact, both officials are inflation hawks, meaning they would have advocated tighter financial conditions, even if doing so meant asset prices started to level off.
The issue exposed by this latest scandal is not the existence of a few bad apples in a fundamentally stable cart; it’s that the cart itself is completely broken. Independent central banks are completely unfit for a world in which policymakers are targeting long-term interest rates: these decisions are critically important for determining who gets what in our economy and need to be subject to democratic accountability.
The imperative, then, is to democratise central banks. But that imperative is precisely what politicians and technocrats on both sides of this scandal are seeking to avoid.