Cover Story

Author: Ronald Fink

The central banker’s job today is certainly difficult. But it had better not be impossible.

Governors of the world’s central banks face difficult choices as they are increasingly tasked with promoting financial stability and providing a boost to growth. Not all central bankers—or other stakeholders—believe this is, or should be, their role. What’s more, the tools at their disposal may have limited effects and unforeseen consequences, leaving the bankers between a rock and a hard place.

The Bank for International Settlements (BIS) caused a firestorm in monetary circles on June 29, when the institution that serves as the central bank for central banks called in its annual report for constituent institutions to raise interest rates in order to keep asset bubbles from threatening financial stability.

But pricking bubbles is not technically part of the banks’ mandates—the last one (in the US housing market) sparked the Great Recession, from which the global economy has yet fully to recover. And central bankers now consider financial stability part of their job of maintaining price stability and, at least in some cases, full employment.

But the BIS pointedly dismissed the banks’ other tool for maintaining stability, “macroprudential” regulation (using regulatory change rather than monetary policy adjustments to effect change in the system), as ineffectual. And if that contention is accurate, it lends support to former US Treasury secretary Lawrence Summers’ recent observation that current conditions leave policymakers with an unwelcome choice between recession and crisis.

Federal Reserve chair Janet Yellen clearly hopes to avoid this no-win scenario. “Monetary policy faces significant limitations as a tool to promote financial stability,” Yellen said in a speech to the International Monetary Fund within a week of the BIS report. “Its effects on financial vulnerabilities, such as excessive leverage and maturity transformation, are not well understood and are less direct.” Her remarks also made clear her strong preference for regulation as the Fed’s primary tool for maintaining stability.


The disagreement between the BIS and Yellen reflects a larger argument about the role of central banks in today’s economy, an argument that has mushroomed since the financial crisis required them to stave off depression.

No one except an extreme anti-interventionist argues that central banks shouldn’t have undertaken the measures they enacted. But more than a few critics consider the vast, programmatic purchases of privately owned bonds, known as quantitative easing (QE), undertaken by the Federal Reserve, Bank of England and Bank of Japan—and soon perhaps to be undertaken by the European Central Bank, as well—to be ineffectual, risky or both. Now that the global economy has emerged from the recession that followed the crisis, many of these critics contend interest rates should rise sooner rather than later, at least in the US, to prevent inflation if not a meltdown in asset prices.

There is greater clarity as to what the Fed is planning.

~ Amando Tetangco Jr, Bangko Sentral ng Pilipinas

“Interest rates will inevitably have to rise,” says Amando Tetangco Jr, governor of the Philippines central bank, Bangko Sentral ng Pilipinas. Low rates, Tetangco says, encourage risk-taking, and “this can be destabilizing to the real economy.”  He sees little difference in the positions of the BIS and Janet Yellen, noting that it amounts to a question of timing.

Others, however, think the banks should do even more to bolster weak growth, and sometimes contend that central bank activism should be accompanied by fiscal stimulus. Still others think fiscal stimulus should now be prioritized over monetary tools.

These are the confusing, sometimes overlapping lines of battle that have emerged over the future of central banking. It’s a battle that goes well beyond the usual spats between hawks and doves.

“Where some see depression everywhere, the hawks see inflation everywhere,” says Tim Duy, an economics professor at the University of Oregon. And Duy notes that the divergence in views is now much deeper than what prevailed 10 or 15 years ago, when monetary policy alone was deemed sufficient for managing the economy.

Not only are the lines between monetary and supervisory policy blurring, but so too is the line between those two policies and fiscal regimes. In fact, some critics contend QE amounts to making fiscal policy: It reduces governments’ borrowing costs and threatens central banks’ independence, since such policy must be answerable to the public.

Furthermore, using monetary policy to impact markets—for example by adjusting rates to affect property market prices—may simply boost asset prices without substantially increasing lending to, or investment by, the private sector. For that reason Richard Koo, chief economist at the Nomura Research Institute, characterizes QE as “crazy.”

Papadimitriou, Levy Economics Institute: The Fed is in a tigh spot because of fiscal policy.
Posen, Peterson Institute: Central banks will only be able to meet their goals by engaging in intervention.