LONDON (Reuters Breakingviews) - How much influence should central bankers wield in a democracy? That’s the question Paul Tucker ponders in “Unelected Power: The Quest for Legitimacy in Central Banking and the Regulatory State”. His answer is thoughtful and robust. It also contains some uncomfortable conclusions for monetary authorities, which have emerged from the wreckage of the global financial crisis with enhanced powers. Less clear is whether fractious politics, or the demands of keeping the world economy upright, will permit such a fundamental rethink.
Over the past decade, central banking has confronted a paradox. Though the U.S. Federal Reserve, European Central Bank, and others largely failed to see the crisis coming, they played a crucial role in cushioning the subsequent downturn. In doing so they have tested – and at times exceeded – the limits of what they were previously allowed to do.
Monetary policymakers’ reward has been new powers. Some have been given – or, in the Bank of England’s case, regained – responsibility for regulating banks. In most developed economies, central bankers are now explicitly charged with spotting and deflating asset bubbles. Meanwhile, politicians have largely relied on ultra-low interest rates to gradually correct weak post-crisis growth.
Tucker believes this is an unsustainable state of affairs. Central bankers are being sucked into deeply political decisions over how the government is financed, and how income is distributed. Yet these “overmighty citizens” have no electoral legitimacy. At the same time, frustrated voters in the West have turned to demagogues. As a result, central bank independence is under threat.
Tucker, who spent three decades at the Bank of England until he stepped down as deputy governor in 2013, had a close-up view of the crisis and its aftermath. Yet readers hoping for revelations about whether he knew that some British banks were fiddling the London Interbank Offered Rate, or his relationship with former Governor Mervyn King, will scan the book’s 568 pages in vain. In its place is a deep and serious attempt to explore the ways in which democracies delegate authority to independent bodies.
That is not a new challenge. Governments have trusted independent judges and military generals for centuries. Utility regulators and central bankers were granted autonomy more recently. Tucker meticulously explores the legal, economic and sociological arguments for handing over power – as well as the ways politicians retain oversight. Observations about the U.S. constitution are mingled with explanations of the German Bundesbank’s resistance to regulating banks (because that might dilute its constitutional independence).
Tucker distills these ideas into a “Money-Credit Constitution” for central banks. This includes a target for inflation; a requirement that lenders hold reserves; a promise to provide liquidity to sound banks; the power to wind down failing ones; and limits on the size of the central bank’s balance sheet. A decade ago, only the first of these would have been considered mainstream. Yet one of the few benefits of the crisis is that central bankers have relearned the importance of maintaining a stable financial system.
These principles would constrain some central banks today. The Fed’s mandate to stabilise prices and maximise employment is fuzzier than a simple inflation target. European countries rely too heavily on the ECB to keep the euro zone intact. Meanwhile the Bank of Japan’s promise to hold 10-year government bond yields at around zero puts it, in Tucker’s memorable phrase, “in the antechamber of monetisation” of the country’s vast national debt.
Enacting this principled vision will, however, be a challenge. Most Western democracies are deeply divided. It’s hard to imagine the U.S. Republican and Democratic parties agreeing on limits to what the Fed should do. In Britain, the Conservative government and opposition Labour party hold conflicting views on whether the state should spend more. And euro zone countries have so far failed to introduce any significant reforms to strengthen the single currency area. In the absence of agreement, central banks remain the only game in town.
Second, the next recession is almost certain to arrive before central banks have finished unwinding emergency policies from the last crisis. In the absence of a political response, the pressure to consider even more radical moves – such as outright money-printing – will be intense.
Whether Tucker will get a chance to put his ideas into practice remains to be seen. Though he was passed over when the government picked a BoE governor in 2012, he is likely to be a contender when Mark Carney vacates the position next year. Whoever takes on the job will find this book a comprehensive and thoughtful guide to the limits of their unelected power.