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Limiting Central Banking

Summary:
From Moneyandbanking blog Since 2007, and especially over the past year, actions of public officials have blurred the lines between monetary and fiscal policy almost beyond recognition. Central banks have expanded both the scope and scale of their interventions in unprecedented fashion. This fiscalization risks central bank independence, thereby weakening policymakers’ ability to deliver on their mandates for price and financial stability. In our view, to find a way to back to the pre-2008 division of responsibilities, officials must establish clearer limits on what central banks can and cannot do. …… So, what should central banks do and not do? First, it is fiscal authorities that ought to make the unavoidably political choices that directly influence resource allocation. Governments

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From Moneyandbanking blog

Since 2007, and especially over the past year, actions of public officials have blurred the lines between monetary and fiscal policy almost beyond recognition. Central banks have expanded both the scope and scale of their interventions in unprecedented fashion. This fiscalization risks central bank independence, thereby weakening policymakers’ ability to deliver on their mandates for price and financial stability. In our view, to find a way to back to the pre-2008 division of responsibilities, officials must establish clearer limits on what central banks can and cannot do.

……

So, what should central banks do and not do?

First, it is fiscal authorities that ought to make the unavoidably political choices that directly influence resource allocation. Governments already have a myriad of institutions that do so. For example, the United States has government loan guarantee programs for housing, farm, small business, and student loans. Unelected central bankers should not control the scale and mix of programs like these. And governments should not conceal such fiscal actions on the balance sheet of the central bank. In a democracy, doing so lacks legitimacy and would become unsustainable.

As Paul Tucker notes in his excellent book, Unelected Power, legitimacy requires that appointed technocrats not engage in activities that primarily address the distribution of resources within a society (see here). Tucker also highlights the need to concentrate central bank authority where (as a result of the problem of time consistency) only they can achieve policy success at relatively low cost. This means restoring (as soon as possible) the focus on the traditional goals of price and financial stability.

At this stage, to ensure that central banks can do what they are designed to do well, we need to impose clear boundaries on the scope of what they are authorized to do, limiting both what they can buy outright and to whom they can lend. Doing this requires a fine balance, as we need to make sure that policymakers can still aid in a crisis. But, it should not be easy for policymakers to evade the restrictions. Most of all, we need a system in which central bankers are not left feeling that they are the only game in town, so that when monetary policy hits the limits of its effectiveness, they are not obliged to act in quasi-fiscal ways that threaten their legitimacy.

In this (and in other ways), to be successful, their discretion must be constrained.

Amol Agrawal
I am currently pursuing my PhD in economics. I have work-ex of nearly 10 years with most of those years spent figuring economic research in Mumbai’s financial sector.

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