Central Banks

Blaming the Wrong Institution

  • Why it matters

    Why it matters

    Inequality has become a major problem in western society. With politicians at a stalemate, the Fed and the ECB have had no choice but to step into the void, the author argues.

  • Facts


    • Both the Fed and the ECB have kept interest rates at record lows of near or below zero since the 2008 financial crisis.
    • U.S. president-elect Donald Trump has accused Fed Chair Janet Yellen of supporting policies that favor President Barack Obama.
    • German Finance Minister Wolfgang Schäuble has argued the ECB is undermining savers and retirees in the country and even accused the central bank of fuelling support for right-wing protest groups.
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The ECB, like the Federal Reserve, is under attack for doing its job. Source: DPA

The independence of central banks is currently being questioned around the world these days. While Republicans in the United States have been doing this for a long time, they now have much more power than before, thanks to the election of Donald Trump. In Britain, the Bank of England has been attacked from both the right and the left. And in Germany, attempts to curb the European Central Bank (ECB), by taking it to court, amount to the same thing.

The reasons for all of these attacks are broad – but ultimately not valid.

Perhaps the most serious accusation is that the central banks have no democratic legitimacy, something that has become more apparent as central banks have gained more and more power and influence in recent years. Besides that, they are often reproached for the unwanted side effects of their monetary policy, such as low interest on savings, the inflation of capital markets and, in Europe, redistributing wealth among individual countries in the euro zone.

Defenders of the independence of central banks usually argue that they have been valuable in fighting inflation. This is true, but in the long run that alone is not enough to serve to legitimate these powerful institutions. Otherwise, any period of higher inflation could serve as justification to subject central banks to the dictation of a government or parliament.

Two issues are critical in this ongoing debate over independence. First, every modern democracy also needs stabilizing elements that are independent of everyday politics. This is not a contradiction to democracy but is complementary to it. Such categories include constitutional courts in nearly all countries or, in the case of Germany, the president (a largely ceremonial post here).

Because monetary policy is supposed to be designed for the long term and is extremely difficult to comprehend, not just for voters, it certainly makes sense to disconnect central banks from everyday politics, as well.

The second issue is that, in many cases, both the new powers of central banks and the attacks on them ultimately revolve around redistribution conflicts.

For example: Instead of creating a proper social distribution policy, the United States in the early 2000s strongly promoted private homeownership. As a result, it sanctioned the building of irresponsible private debt, in order to at least create the impression of social equality. The result was the financial crisis, and the U.S. central bank, the Federal Reserve, is still dealing with its consequences today – primarily by promoting debt relief for much of the country with low interest rates.

These redistribution conflicts are often glossed over by excessive government debt, which make it possible for capitals to spend money without raising taxes. In the end, these government debts also need to be offset by the central bank – this was done through inflation in the past, but today is done mainly by keeping interest rates artificially low.

It’s the same story in Europe. The only reason the ECB has come under a spotlight on the continent is because euro zone countries have been unable to come to grips with the disparity between economically strong and weak regions of the 19-nation currency bloc.

Instead of governments being honest about the need for redistribution of wealth between rich and poor members, they have left the task of fiscal equalization up to the ECB, which has no choice but to steer monetary policy in favor of weaker members if it hopes to avoid a collapse of the financial system.

The new attacks being leveled at central banks are ultimately nothing but attempts to carry these unresolved conflicts over redistribution over to these institutions. Politicians now say the ECB should refrain from taking actions that result in money leaving Germany; they say both the ECB and the Fed should stop discriminating against savers for the benefit of borrowers.

All of this is understandable, but can have catastrophic consequences. If politicians are unable to reach compromises in the political realm, how will they be any more successful when interfering in monetary policy? If these tensions are brought even further into central banks, there is a risk that they will develop even more blasting power, without getting resolved.

Another issue that is often overlooked by the attackers: By and large, the central banks are simply pursuing the goals that have been set by lawmakers. These goals of monetary policy also threaten to fall by the wayside if critics have their way.

The twin tasks of the U.S. central bank are to promote price stability and economic growth. At the ECB, the emphasis may be placed somewhat more heavily on price stability, but the statutes of the network of European central banks known as the ESCB, which is often equated with the ECB, also state that: “Without prejudice to the objective of price stability,” the ESCB shall “support the general economic policies in the Union.” In other words, the ECB has largely the same objectives as the Fed and is justified in pursuing those same objectives.

Both central banks are simply fulfilling their legal mandate. Politicians should steer clear of them.


To contact the author: wiebe@handelsblatt.com

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