Tyranny of the Central Bankers
By Dean Baker
International Relations and Security Network
18 April 2011
http://www.isn.ethz.ch/isn/Current-Affairs/ISN-Insights/Detail?lng=en&id=128515&contextid734=128515&contextid735=128413&tabid=128413


The worst economic downturn in 70 years has failed to
change the behavior of central bankers. Recent decisions
to maintain inflation rate targets at the expense of
employment and output only highlight the need to hold
central bankers more accountable for how they manage the
economy.

The European Central Bank (ECB) announced earlier this
month that it was raising its overnight lending rate by
a quarter of a percentage point to 1.25 percent. This is
very bad news for people across the eurozone countries
and possibly the rest of the world as well.

This action shows two things. First, the ECB is prepared
to slow the eurozone economy and throw people out of
work. This is the point of raising interest rates. The
ECB targets two percent inflation with the current
inflation rate in the eurozone around 2.5 percent.. The
inflation rate is above the ECB target due to a jump in
the price of oil and other commodities. These price
rises in turn are primarily attributable to instability
in the Middle East and increased demand from China,
India and other fast-growing developing countries.

Raising interest rates in the eurozone will do little to
reduce the prices of commodities. However if higher
interest rates throw enough people out of work in the
eurozone, it can place sufficient downward pressure on
wages to offset the impact of higher commodity prices.
If commodity prices rise by much more than two percent,
then the ECB can make wages rise by less than two
percent, thereby returning to its magic number and
declaring 'mission accomplished'.

This brings up the other fact demonstrated by the ECB's
action. It has learned nothing from the events of the
last three years. Those who hoped that the worst
economic downturn in 70 years might change the Bank's
behavior are sure to be disappointed. It continues to
adhere to its goal of maintaining an inflation target
oblivious to the costs in unemployment and lost output.

Unfortunately, the ECB is not alone in this respect.
Most central banks are now controlled by inflation
targetters who explicitly ignore the impact of the
banks' actions on output, employment and financial
stability.

A deficit of democracy

The worst part of this story is that these fundamental
decisions about economic policy are made by a small,
secretive clique operating largely outside of the
public's purview. Central bank decisions on interest
rates are likely to have far more impact on jobs and
growth than any of the policies that are debated
endlessly be elected parliaments. Yet, these decisions
are made largely without democratic input.

In fairness, politicians bear much of the blame for this
situation. They established institutional structures
that largely place central banks beyond democratic
control. There is probably no bank that is as insulated
from the democratic process as the ECB, in large part
because of its multinational structure, but all the
central banks in wealthy countries now enjoy an
extraordinary degree of independence from elected
governments. In many countries they are even more
independent than the judicial system.

Even worse, the politicians have actually mandated many
central banks, like the ECB, to pursue an inflation
target to the exclusion of other considerations. This
gives the central bankers a license to throw millions of
people out of work in order to chase their obsession
with inflation.

Giving the central bankers free rein to chase inflation
targets could perhaps be justified if they had a track
record of success, but they don't. The world economy
stands to lose more than $10 trillion in output because
of the central banks' failure to stem the growth of the
dangerous housing bubbles.

While the central bankers were congratulating themselves
for hitting their inflation targets, the bubbles were
growing ever larger, and the financial system was
becoming more highly leveraged. All they could express
when the bubble finally collapsed in 2008 was their
surprise.

In other professions, people would have been fired for
such a momentous failure. However if any central banker
lost their job due to this disaster, the firing was kept
very quiet.

The economic crisis should have taught central banks
that it is not sufficient to pursue an inflation target;
maintaining high levels of employment and overall
financial and economic stability are also important -
and failure to meet these challenges should result in
replacing the current crop of central bankers.

Processes must also be in place to hold the central
bankers accountable to elected governments. The choices
they make involve issues on which the public should have
input, particularly the tradeoff between higher
unemployment and the risk of more inflation.

Naturally, different actors will take different
positions on this tradeoff. The financial firms, who
tend to be close to the central bankers, are unlikely to
be very concerned about the cost of unemployment.
However, they will view the risk of higher inflation
with enormous trepidation because it will typically lead
to large losses for the industry.

The larger public is likely to take the opposite
position, as moderately higher rates of inflation pose
little cost. This choice should be the sort of topic
that arises in political campaigns, since it is likely
to have far more consequence for the public than
whatever tax or spending policies the competing parties
are promoting.

None of this means that we want politicians deciding
interest rates. However, the people who do decide them
should be answerable to politicians in a way that is not
true today. In this way central banks should be like any
other regulatory agency. For example, politicians do not
decide which drugs the US Food and Drug Administration
approves. However if it goes five years without
approving any drugs - or approves a number of them that
cause sickness and death - serious problems ensue.

In short, this is simply a question of restoring
accountability to the central bankers for their
management of the economy. The days of the central bank
as a church beyond the reach of the commoners should be
brought to an end.

___________________________________________

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