The unenviable job of a central banker

Central bankers should be seen more than heard, goes a saying. With the advent of the global financial media, a central banker now typically seems to be seen and heard more often in one context or the other in some part of the world. World markets look out for the stance of central banks with great interest and analysts keep a close tab on their meetings calendar. Expectations on central banks’ actions often outpace their outcomes.

Central banking has evolved over long time. Looking after coinage and printing of notes was one of the first tasks the Bank of England took up as an independent function in 1861, with the US Federal Reserve in 1913 assuming the role of a lender of the last resort. The Nixon shock in 1971 — delinking the dollar with gold for setting value and printing of money — added currency management as a critical function.

The Middle East’s oil embargo in 1973 added hyperinflation to prevailing recession then, reigning of which became the core aim. Accomplishing this feat made the then US Fed Chairman, Paul Volcker, a folk hero in the world of central banking. It’s a different matter now, as stoking a bit of inflation into the system has become a central tactic in reviving developed markets’ growth.

Financial evolution

Post the dollar-gold delink, a huge surge spawned in trade and economic growth. It also gave birth to new market segments such as Eurobonds, the concept of which spread farther — Japan’s Samurais, China’s Dragons, Kangaroos of Australia, Matadors (Spain), Maples (Canada) and India’s Masala bonds.

As economies became larger and markets turned deeper, global finance began to seek new avenues for investment, which prompted the International Finance Corporation to come up with a shortlist of 10 promising markets from the developing world named ‘emerging markets’. A separate asset class came into being, with more markets added over time with a different set of risks that expanded the mandate of central banks.

The heightened pace of global financial flows over time expanded the realm of emerging markets and created overheating in some of them, along with the shifting of the economic balance between the developed and developing world, that incidentally became a basis of crisis that ranged from the tequila effect in Mexico (1994) to the Asian crisis (1997), Latin America and the LTCM crisis (1998), economic recession brought on by the bursting of the dotcom bubble and corporate failures (2000) to the global financial crisis of 2008.

These developments called for strong interventions from central banks.

Pressures and pitfalls

Central banks also had to fight battles from within and often cope with the pressures of politics. If Stanley Fisher of the US Fed stood strongly for central bank independence, Bundesbank during the German unification (1990) had to yield to the political decision of exchanging at par one East German Mark with that of West Germany, despite a huge difference in value between the currency.

Central banking faced huge embarrassment in 1992 during the ERM crisis, when the combined might of the UK’s Treasury and the Bank of England was humbled by hedge-fund players like George Soros, who said: “When Norman Lamont (the British finance minister) said just before the devaluation that he would borrow nearly $15 billion to defend sterling, we were amused because that was about how much we wanted to sell”.

Former US Fed chairman Alan Greenspan’s ‘Put’ strategy, criticised by Joseph Stigliz as privatising profits and socialising losses, spread a false sense of belief that the Fed will rescue whenever asset prices take a huge fall.

It finally culminated in an unprecedented meltdown in the global economy, the effects of which are still reverberating across the world.

Adding to the embarrassment is the frustration of not being able to stimulate pace in economic growth, despite long and sustained measures of support and monetary easing, and even after resorting to negative interest rates, which began with Sweden in 2009 and was soon adopted by few other developed markets. The trend had to be reversed in December 2019, since banks are willing to pay interest to central banks on their reserves rather than pushing more credit.

Increasing challenges

If the past remains unsolved, the present looks quite grim. The world is just away from a 0.5 per cent decline in growth before it slips into a recession. Average global real GDP growth is now at 3 per cent, down from 3.8 per cent in 2017. The ‘Major Four’ (the US, the EU, Japan and China) are poised to see more pain going forward; China is not able to see past glory in growth despite spending $21 trillion in stimulus.

Shadow banking increased its clout to up to 40 per cent of the nearly $400 trillion of total global financial assets, whereas debt levels elevated to new highs raising warnings. Of the 43 countries that The Economist tracked in 2019, 38 reduced interest rates, 23 sawcurrency depreciation and 31 faced budget deficit, a good 28 economies are seeing a yearly real GDP growth of less than 2.5 per cent, just putting them on the verge of a recession.

Barely are these problems grasped, that equally compelling challenges loom ahead — cryptocurrencies, private markets, digital finance — which have already found a fair share of market support despite reservations at some central banks.

A key constraint of central banking is finding the right spot that its policy can hit effectively. The pass-through of the policy happens across four important stages, the first being the financial system where the impact is seen immediately, followed by the second stage of spending patterns and investments in the real economy. The third stage deals with asset prices and wealth generation; and finally consumption comes in the fourth stage. The inability to gauge where policy makes most impact is what Ben Bernanke, former Fed chairman, described as a ‘Black Box’.

So be kind and sparing when taking on central banks with criticism. Much of their job today is thankless, and more of it is slipping out of their reach and influence. Blame the power of markets.

The writer runs the consulting firm ‘Growth Markets Advisory Services’. Views are personal