In years gone by, central banks were supposed to be the guardians of monetary discipline – vigilant in protecting citizens against inflation and currency debasement. They were rarely known to smile.
Bankers used to quake every time the governor of the Bank of England twitched an eyebrow. Former Federal Reserve chairman Paul Volcker developed a fearsome reputation for taming inflation in the early 1980s.
But the times are changing to suit economic circumstances, as anxious politicians bend central bankers to their will.
They know their voters are weary of austerity packages and economic stagnation. They are terrified of social unrest and the rise of fringe political parties.
While they still have time, governments are making it clear they want central bankers to boost their economies and stop being miserable.
New Japanese prime minister Shinzo Abe has even vowed to put a formal end to the independence of the Bank of Japan if it fails to restimulate the economy massively following a 20-year slump.
In a research note, Bank of America Merrill Lynch argues the level of central bank intervention is unprecedented. It is evident worse conditions will cause even greater activity. According to Merrill chief investment strategist Michael Hartnett: “I’m so bearish, I’m bullish.”
Paul McCulley and Zoltan Pozsar of the Global Society of Fellows have just published a research paper*, which points out central banks regularly work with governments in times of financial trouble, only regaining their independence when private sector exuberance needs to be reined in.
They cite US Federal Reserve chairman Ben Bernanke, who told the Japanese soon after their slump began: “Greater cooperation for a time between central banks and fiscal authorities is in no way inconsistent with the independence of central banks.” He compared it to alliances between nation states, like the US and Japan.
The argument runs central banks should help restore animal spirits before descent into economic depression becomes terminal. This means keeping interest rates close to zero for a prolonged period. Another tool in the monetary box involves the printing of money through quantitative easing to buy bonds and other assets owned by investors. This keeps bond yields down and frees up money for investors to use elsewhere. In addition, short-term bonds can be issued to buy back long-dated bonds to improve the changes of borrowers getting access to cheap debt.
Central bankers also need to communicate the positive. They can also pledge to keep rates low for a long period, vow not to resell bonds purchased through QE (or cancel them altogether) and express optimism over the state of the economy.
Ben Bernanke knew what needed to be done as a result of his research into the US Great Depression of the 1930s. He earned renown for his comments that central banks should be prepared to drop money out of helicopters to fight deflation.
Bernanke’s helicopters were left on the ground a couple of years back, out of fear that money drops would wreck US government finances – a theme picked up by Republican politicians in the Tea Party movement.
But a stop-start policy does not work when economies are stagnant, and people are looking for excuses to stop spending money.
Last year Bernanke pledged to repurchase mortgage bonds worth $40 billion (€30 billion) once a month. He also put a monthly $45 billion swapping of long-term debt for short term debt in train and pledged rates would be kept close to zero “as long as the unemployment rate remains above 6.5%”. The US housing and stock markets are finally responding to treatment.
UK chancellor George Osborn made it clear that he would not tolerate foot dragging by the Bank of England when he appointed Mark Carney to succeed retiring governor Sir Mervyn King rather than deputy governor Paul Tucker. Carney promptly suggested countries should consider targeting economic recovery, rather than inflation. It is hard to imagine King using such forthright language, less still Tucker.
Jean-Claude Trichet, former chairman of the European Central Bank, never seemed to have an adequate response to the eurozone crisis. Still a misery, he recently called the impact of QE on ballooning bank balance sheets “profoundly abnormal”.
But his successor Mario Draghi has pushed Germany, its reluctant paymaster, as hard as he can, pledging to make unlimited purchases of stricken eurozone bonds when necessary.
Draghi’s pledge to do “whatever it takes” to save the euro has stopped the bears in their tracks.
European stock markets have moved higher and German chancellor Angela Merkel’s opinion poll rating has soared. Tim Skeet, managing director of RBS Financial Institutions, said: “Psychologically, the market has decided the euro will survive. That’s what’s made the difference.”
Elsewhere, moves are being made by China to liberalise its economy and open its stock market to western institutions, suggesting a degree of coordination between global economies to pull themselves out of a hole.
Nothing has changed, of course, about the indebted state of our economies. But, at this juncture, there seems little point letting the facts get in the way of a good story.