By Tomasz Janowski and Paul Carrel
TOKYO/FRANKFURT, April 18 It is your first day
as the new U.S. Federal Reserve chief: the main interest rate is
4.50 percent, the economy is overheating and the task is to keep
inflation and unemployment low.
Once in a while there is a curve ball -- an oil crisis or a
dollar spike -- and if you move rates up or down appropriately
you will be reappointed.
Central banking was never as straightforward as "Fed
Chairman", an online game created by the San Francisco Fed over
a decade ago for high school and college students.
But playing it could make Ben Bernanke and his global
counterparts long for simpler times.
A 3-D shootout game would now be closer to reality as they
reluctantly fill the policy void left by hamstrung governments,
at risk of overreaching and experimenting with measures that may
have unpredictable consequences.
"There was a time, not too long ago, when central banking
was considered to be a rather boring and unexciting occupation,"
European Central Bank President Mario Draghi said this week.
"Some thought that monetary policy could effectively be
placed on auto-pilot. I can confidently say that this time has
There has been no respite since the 2008 global financial
crisis. Top central banks have slashed rates to zero, pumped in
vast amounts of cash, helped orchestrate bailouts and fired
their "big bazookas": buying trillions of dollars of government
bonds to calm markets and spur lending and growth.
Whatever they do never seems to be enough for governments
saddled with high debt and markets still fighting the hangover
from the debt-fuelled binge that preceded the crisis.
But here is the paradox: humbled, constantly pressured by
politicians and having lost much of the respect accorded to
former Fed Chairman Alan Greenspan and his colleagues in their
heyday, central bankers are more important than ever.
They are expected to preserve financial stability and
engineer economic recovery that political leaders by and large
have been unable to produce. That is a radical departure from
the 20th century model, where central banks focused on curbing
inflation and protecting the value of their currencies.
"Monetary policymakers have become not only the lenders of
last resort, but the policymakers of last resort," said Barry
Eichengreen, a University of California professor and expert on
the international monetary and financial system.
In Japan, Prime Minister Shinzo Abe is looking to the
central bank to end deflation, British Finance Minister George
Osborne hopes new Bank of England head Mark Carney can succeed
where he has failed and revive the economy. Last month it was
the ECB that threatened to cut off funding to Cyprus if it did
not agree a bailout plan.
When short-sellers breathe down distressed governments'
necks every time they hold a debt auction, unelected central
bankers can act quickly enough: no lobbying, trade-offs or
parliamentary votes required.
They also have something governments desperately lack:
money. In fact, like modern-day alchemists, they can and are
creating it in unprecedented amounts.
Following the crisis there is a broad agreement that low
inflation is not enough for economic success. Financial
stability is also essential but there is no consensus on what
role central banks should play in achieving that.
Central bankers hark back to simpler times but critics say
many of today's woes are due to complacency in the good times.
"There is this nostalgia among central bankers about the
good old days of the 1990s and early 2000s when you just set
interest rates and all was very straightforward, but that was a
delusional paradise," says Adam Posen, a U.S. economist who
served on the Bank of England's policy council in 2009-2012 and
now heads the Peterson Institute, a Washington think-tank.
The crisis shattered the theory of "Great Moderation", that
solid growth could go hand-in-hand with low inflation and bull
markets if central banks focussed on price stability.
Today, economists and central bankers see two mistakes:
giving policy too much credit for what was in part an effect of
China's rise as a low-cost manufacturing powerhouse, and
underestimating risks brought by sweeping deregulation.
After the crisis new risks for central bankers have emerged.
One is that out of a sense of duty -- or caving in to
pressure from politicians, investors and the public -- central
banks will end up promising more than they can deliver.
"A worry is that monetary policy would be pressured to do
still more because not enough action has been taken in other
areas," Jaime Caruana, chief of the Bank of International
Settlements, said at the bank's annual conference last June.
"As the benefits of extraordinary monetary easing shrink and
become less certain, the risks of expanding central bank balance
sheets are likely to grow. Such hazards may materialise in ways
that are not completely clear today."
Policymakers could also repeat the mistake of the Great
Moderation and confuse broad and permanent structural changes in
the world economy with problems that occur at different stages
of the economic cycle.
Just as the "China effect" on inflation in the 1990s was
underestimated, today the demographic and structural factors
eroding rich nations' economic health are problems that central
banks cannot fix.
"I think there is a little bit of desperation and thrashing
around to find some way of getting a better economic picture,"
said Andrew Sentance, who served on the Bank of England's policy
council in 2006-2011.
"Lots of the reasons for under-performance have nothing to
do with monetary policy, and this is the new normal for Western
economies in general."
Part of that "new normal" could be the average 2 percent
economic growth the United States has seen since the crisis, he
said. Yet the Fed keeps trying to shift the world's biggest
economy into higher gear, having pumped over $3 trillion into
it, equivalent to about a fifth of U.S. annual economic output,
and continuing to buy government bonds and mortgage-backed
Bank of England Governor Mervyn King said back in 2000 that
it was the bank's ambition to be boring. He and his peers at the
Fed, the ECB and the BOJ have been anything but.
Canada's central bank boss Carney, 48, who in July will
succeed King to become the first foreigner to run the BoE in its
319-year history, aims to restore a measure of "boring". He told
UK lawmakers: "I want my exit to be less newsworthy than my
However, some worry that with monetary stimulus affecting
currencies and fund flows, central banks will in fact end up in
an "arms race."
Earlier this month, Japan's new central bank chief Haruhiko
Kuroda delivered spectacularly on his pledge to do "whatever it
takes" to beat deflation with a $1.4 trillion stimulus plan that
accelerated the yen's slide to four-year lows.
The BOJ pioneered the policy of "quantitative easing" a
decade ago, when it switched to targeting the amount of funds
pumped into the economy rather than short-term borrowing rates.
But later it lost faith in its effectiveness and only under
Kuroda has it fully embraced the Fed's thinking that the risk of
doing too little is greater than of doing too much.
Spain's Prime Minister Mariano Rajoy wants Europe to look at
changing the ECB's powers to give it instruments other
authorities are using.
"The danger that we drown in money is small compared to the
danger that we slide deeper into crisis and that it gets harder
to get out," said Marcel Fratzscher, former head of research at
the ECB and now head of Germany's DIW economic institute.
But nowhere is unease about expanding the role of central
banks greater than in Germany, home to the fiercely independent
Germans worry that relying on central banks minting cash
creates a dangerous illusion that there are pain-free fixes to
problems of largely political, social or demographic nature.
Another fear is that by venturing beyond their core
responsibility of keeping prices in check, central banks risk
compromising the credibility needed to fulfil that mandate.
While the spotlight is on central banks in the largest
economies, most of the world's monetary institutions have not
reached the limits of conventional interest rate policies. Some,
like Poland's central bank boss, are sceptical of the new tools.
"Ultra-low rates or quantitative easing policy, ...it all
leads to significant economic imbalances," Marek Belka said last
week after holding rates at 3.25 percent. "That's why there's a
willingness to run monetary policy in a conventional way."
With Abe and Kuroda experimenting to try and pull Japan out
of its deflation trap, an elder statesman of policymaking has
also warned against getting carried away again with expectations
of what central banks can do.
"They think they can use deliberate fluctuations in the
inflation rate to manage the economy," said Paul Volcker, 85,
who led the Fed's charge to end high inflation in the 1970s.
"But the central bank is not an all-powerful tool."