11 April 2018

Central Banks into the Breach

From Triumph to Crisis and the Road Ahead

Pierre L Siklos
2017, Oxford University Press, 344 pages,

Reviewer: Dame Kate Barker

The subtitle of this book is ‘From triumph to crisis and the road ahead’ which gives a fair idea of its basic structure.  It starts with an account of central bank policy ahead of the Great Financial Crisis, and the prevailing view at the time, which was that monetary policy makers had worked out how to dampen business cycles as well as keeping control of inflation.  (Notoriously, the Bank of England was hosting a major conference on the sources of macroeconomic stability the day the run on Northern Rock started.)   Siklos’ view, that central banks had ceased to focus enough on financial stability, is now widely accepted.  What remains unclear is whether the policy changes introduced in the wake of the GFC will prove effective, and whether central banks can regain the public trust which has been eroded.

On the key question of the new emphasis given to financial stability, I very much agree with Siklos that monetary policy and macro-prudential policy cannot be conducted in two separate compartments.  Potential conflicts between the two need to be considered and given proper emphasis and this has implications for the organisation of institutions and indeed for the structure of inflation targeting (which may need to become more ‘flexible’ than ever).  In particular he raises the concern that the long delay in returning to more ‘normal’ monetary policy is running the risk of a recurrence of financial instability – an event which public opinion would find it hard to forgive. 

Siklos argues that the need for cooperation runs beyond the domestic to the international.  He criticises the way in which global coordination only tends to emerge in a crisis situation, with no forethought given to the circumstances which would make this appropriate or to how it might be operated. 

Looking at the way in which the major developed economy central banks responded to the GFC, Siklos supports the general approach to policy – although he is dubious about forms of forward guidance which relate future monetary policy actions to the behaviour of real, rather than nominal, variables.  As he points out – the Bank of England’s foray in this regard was not in the end very successful at guiding (though of course it may have supported the economy if it affected expectations and thus behaviour).  His critique however is that since the GFC there has been more uncertainty about policy and that central banks have failed to explain the ‘new normal’.  This seems harsh – economic behaviour has been unexpected in several ways.  It is likely that central banks themselves have not established what a ‘new normal’ is – or even whether we should ever again regard a set of circumstances as ‘normal’. 

He is also concerned about the new (or reinstated in some cases) responsibilities which many central banks now have for financial stability.  Few institutions have been able to define this goal in a satisfactory way, and this runs the risk of reducing the accountability of, and public trust in, central banks. Nor are the instruments used to attain the goal yet well defined.   In particular, it is suggested that the possible conflict between inflation control and financial stability will require the central bank to make judgements about which goal is paramount, often without the benefit of adequate guidance from the elected government.  In this sense there is a clear risk that the institutions are becoming over-burdened. 

There is an interesting discussion of what leads to confidence in central banks.  The GFC brought about a rise in public mistrust of the major central banks, not surprisingly, and in the EU this was most apparent in the countries affected by the sovereign crisis. However, if credibility is measured by inflation expectations, these have not been de-anchored, although private projections of inflation are often not in line with those of the central bank.  In several cases there have been reviews of how the central bank operates – for example the Treasury’s review of monetary policy in 2013. 

The main conclusions include that low and stable inflation remains an important goal which is not widely questioned.  The criticisms of the position central banks now find themselves in includes the suggestion that in the aftermath of the financial crisis central banks ignored the loss of trust.  I am not sure this is true – all players in the affected economies were surely acutely aware that public confidence in the management of financial sector had failed badly and that central banks were judged to be complicit in that failure. 

The other parts of the critique have more merit – that central banks can’t alter the long-term rate of growth, but are reluctant to admit this; that ‘unconventional’ policies have become more conventional, permanently blurring the monetary/fiscal line; and that there is an unacknowledged potential for clashes between monetary policy and macro-prudential.

The remedies proposed are: that the need for international cooperation in times of crisis is recognised and the approach to this set out in advance; that there is a clearer statement of the new relationship between central banks and their respective governments; and, that central banks should place more emphasis on the role of judgment rather than an unduly technocratic approach to policy. 

These conclusions seem sensible – and the book contains much interesting material.  However, the line of argument is often difficult to follow, and the (many) charts are not well-presented.  It is therefore a slightly frustrating read.