Central Bank

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GUEST OBSERVER
Throughout the Presidential campaign Donald Trump repeatedly criticised the United States Federal Reserve, accusing it of creating a “big fat ugly bubble” through its monetary decisions, among many other things. Trump’s consistent attacks have created worries for the Fed’s independence.
These worries intensified after the election, as President Trump will be in a position to make big changes at the Federal Reserve over the next few years. There are two existing vacancies on the seven-member board of governors of the Fed, and the terms of both the current Chairwoman, Janet Yellen, and Vice Chairman, Stanley Fischer, expire in 2018.
But there is more to good central bank governance than independence.
<h2>Why do we care about central bank independence?</h2>
Among orthodox economists, there is a long-standing belief that central bank independence is a sacred precept for any market economy. Independence gives the central bank some freedom from the politicians who might otherwise print money for political reasons. Orthodox economists worry that politicians are susceptible to political moves that are deleterious to stable economic environments, and that their ideologies often have little economic grounding.
Politicians, by this logic, will compromise monetary stability just so they can trumpet to their electorate that they are “driving growth”. There are some merits to this theory, as a long history of bubbles fuelled by short-sighted politicians amply demonstrates.
However, the problem for these orthodox economists, in addition to failing to either predict, explain, or prevent global financial catastrophes, is that the exact faults they attribute to politicians also manifest in unaccountable central banks, most notably the United States Federal Reserve.
<h2>Good governance requires more than independence</h2>
In order for the independence of central banks to work effectively, they need to be self-critical, intellectually honest, and adaptable institutions, as the banks of Canada and New Zealand have a track-record of demonstrating. The importance of a critical approach cannot be overstated. Central banking is an art, not a science, which is why humility is also an important attitudinal factor explaining the success of some central banksas opposed to others.
There is also a cultural aspect that has fuelled the impunity of central banks – it comes from their monopolisation of prestige in economics. Take this example: the Nobel Prize in Economics is given out by the Central Bank of Sweden. Is it really so surprising that a central bank will continually bestow this prize on the guys who argue for central banks to be made all-powerful?
<h2>Central banks must be accountable</h2>
A point that was advanced by both Donald Trump and Bernie Sanders is that there must be some form of accountability for so large an institution, which has such a disproportionate impact on the well-being of people all over the world. If the Federal Reserve were like any central bank whose sphere of influence was relegated largely to domestic monetary authority, then a robust and independent Central bank would not just be desirable but crucial to prevent capture by the short-termism of politicians. However, the US central bank is the printer of the world’s reserve currency and so writes the economic destiny of much of the planet.
Given the global impact of the Fed, there must be some form of mechanism by which it is made answerable for its choices. In a time of “rabid populism,” the idea that a small group of unelected people virtually dictate the price of money (which is basically what interest rates are), is not just abhorrent but downright anathema, and that is what Trump has capitalized on (pun intended).
<h2>Lessons for other central banks</h2>
There are two other central banks that have a disproportional global impact – the European Central Bank [ECB] and the People’s Bank of China [PBOC]. They too have to cater to their domestic economic needs,but find themselves exerting enormous influence over the global economy. And like the Fed, they are also not subject to a consistent oversight mechanism.
Although the PBOC does not face substantial domestic criticism, it continually draws the ire of its international trading partners for its domestic monetary policies. Meanwhile, the ECB is now the equivalent of an economic piñata that is berated by many EU members, for a variety of reasons. The ECB has a very difficult mandate in that it must try to strike a balance between the stable Euro-countries and those that are crisis-afflicted. Its democratic accountability has also been repeatedly called into question.
<h2>What next?</h2>
So what is next for the Fed? As with many Trump “promises,” there seems to be some dithering on whether Trump would actually go after the Fed. However, if pursued, Trump’s impact on the Federal Reserve could be huge. The impact on global equity and bond markets, on the value of the US Dollar, on the money supply, and on ordinary American lives, would be tremendous. 
However, the fact remains that independence alone doesn’t ensure good policymaking. And as populist fervour takes hold, a more accountable mechanism for overseeing monetary authority might be necessary.
Usman W. Chohan is doctoral candidate, Policy Reform and Economics, UNSW Australia and author for The Conversation. He can be contacted <a href="https://theconversation.com/profiles/usman-w-chohan-182272" target="_blank">here</a>.
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There is more to good central bank governance than independence

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<img src="https://counter.theconversation.edu.au/content/73355/count.gif?distributor=republish-lightbox-basic" alt="The Conversation" width="1" height="1">GUEST OBSERVER
The two central banks that matter most for Australians - the Reserve Bank of Australia (RBA) and the US Federal Reserve (the Fed) - released minutes from their latest meetings this week. And although there were not a lot of surprises, there was a fair bit of detail about what we can expect on interest rates going forward.
The Federal Open Market Committee’s (FOMC) main message was unmistakable -expect interest rate rises, and expect them sooner rather than later:
Many participants expressed the view that it might be appropriate to raise the federal funds rate again fairly soon if incoming information on the labor market and inflation was in line with or stronger than their current expectations or if the risks of overshooting the committee’s maximum-employment and inflation objectives increased.
and that they:
continued to see only a modest risk of a scenario in which the unemployment rate would substantially undershoot its longer-run normal level and inflation pressures would increase significantly.
This is exactly what markets have been expecting, and it seems clear that the balance of risks is no longer that the labour market is too weak or inflation too low, but that the Fed might wait too long to continue its path of rate rises.
The really big unknown is how the Fed goes about unwinding a good chunk of its balance sheet, which involves US$2.64 trillion (with a “T”) of treasury bonds that were purchased as part of its effort to stimulate the economy in the wake of the financial crisis. The Fed also holds around US$1.75 trillion of mortgage-backed securities (“MBSs”).
The natural way to unwind this is by not reinvesting those funds when the securities mature. The Fed gets its money back and doesn’t purchase new treasuries or MBSs.
But it’s more complicated than that. New post-crisis capital rules require commercial banks to keep a large amount of reserves sitting at the Fed. This is now around US$2 trillion. The Fed has to match this liability with assets, like treasuries.
Nobody knows, but my guess is that the Fed shifts MBSs to treasuries over time, but has to keep a large asset side of the balance sheet. This suggests that maybe the whole balance sheet unwinding problem may not be as significant an issue as first thought. But this is genuinely unchartered territory.
At home, the RBA minutes confirmed the ongoing dilemma governor Philip Lowe faces. Like his predecessor, Glenn Stevens, Lowe is trying to manage: unemployment, the Aussie dollar exchange rate, business investment, overall growth, inflation and housing price stability all at the same time, but with only one instrument: the cash rate.
To see this, just look at the opening sentences of the long section of the RBA minutes titled “Considerations for Monetary Policy”. They read as follows:
In considering the stance of monetary policy, members viewed the near-term prospects for global growth as being more positive, although recognised the risks from policy uncertainty in the medium term… Domestically, the economy was continuing its transition following the end of the mining investment boom… Non-mining business investment was also expected to gain some momentum…
Conditions in housing markets varied considerably across the country… Inflation outcomes for the December quarter were much as had been expected and there had been very little change to the forecast for inflation…Labour cost pressures were expected to build gradually from their current low levels…
Wow. That’s a whole lot of targets to try and hit with a single (non-magic, non-silver) bullet. No wonder Dr Lowe has now taken to giving speeches that essentially plead businesses to invest.
It hasn’t quite gotten to “there’s never been a better time to be a business in Australia”. But close. It may, however, be that it’s never been a tougher time to be a governor of the RBA.
Richard Holden is professor of Economics and PLuS Alliance Fellow, UNSW and author for The Conversation. He can be contacted <a href="https://theconversation.com/profiles/richard-holden-118107" target="_blank">here</a>.
 
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