In the Forbes list of The most powerful people in the world for 2012, held Ben Bernanke, then chairman of the US Federal Reserve, the sixth place, while Mario Draghi, the then President of the European Central Bank, came in eighth. Both were ranked above Chinese President Xi Jinping. As the global economy grappled with the aftermath of the global financial crisis that began in 2008 and its European cousin, the euro crisis, the central banks sat at the forefront and gave way quantitatively as if there was no tomorrow. They were, it was often said, “the only game in town”. Even then, some thought there was an element of folie de grandeur in their height.
This time it’s different. Although central banks continue to buy bonds incontinent, fiscal policy has been the main response to the Covid-19 pandemic. In the US, President Joe Biden and Congress have led the indictment. In the EU, the European Commission’s Recovery and Resilience Facility is at the heart of the EU’s next generation plan worth € 750 billion (£ 650 billion), while in the UK Chancellor Rishi Sunak signs the checks.
Are the central bankers’ noses out of joint when they play second fiddle to finance ministries, a position in the orchestra that few aspire to?
It seems they are, because in the past 18 months the activity of central banks has expanded remarkably, largely driven by their own ambitions. So you’ve stepped into the climate change arena, arguing that rising temperatures could jeopardize financial stability, and that central banks, as bond buyers and banking regulators, can and should proactively increase the cost of borrowing for businesses without increasing borrowing costs – a credible transition plan. This is a promising new business area that is expected to grow.
Central banks are also trying to get into social engineering, particularly the policy response to rising income and wealth inequality, another hot topic of high political concern. In part, this new interest in inequality is a defensive move. Central banks have been stung by growing criticism that their policy mix of low or even negative interest rates combined with quantitative easing has brought huge untold gains to wealthier members of society by driving up asset prices.
The fortunate members of society with money to invest in stocks, quality real estate, and expensive works of art have seen their net worth grow rapidly as the funds poured into asset appreciation. The central bankers were thus forced to defend their actions and to prove that the chosen policy mix also benefited poorer families by keeping jobs. Some have been convinced by this argument; others not so much.
The mixed reaction has sparked another reaction from the monetary authorities. One element was rhetorical. In 2009, less than 0.5% of all speeches recorded in the Bank for International Settlements (BIS) database by all central bankers mentioned inequality or the redistributive consequences of their policies. In 2021 it will be 9%, almost 20 times as many.
But talking is cheap. Is there any evidence that concerns about inequality have influenced politics? Is there actually evidence that monetary policy can be used to mitigate or reverse growing inequality?
The chief economist of the BIS, Claudio Borio, believes there is. He argued late last month, “Monetary policy can do a lot to promote fairer distribution across business cycles.” Part of the argument is traditional and comes from the central banking textbook 101. It points to “the chaos that comes with high inflation.” in the poorer sections of society ”and shows that income inequality tends to decrease when inflation averages below 5%. So far, so conventional.
But he admits that holding rates low for a long time to stave off a recession can be a problem. In these circumstances, “there might be a compromise on wealth inequality”. This applies in particular to financial recessions, which can last longer and in which interest rates have to be kept low over a longer period in order to reduce excess credit. So what’s the answer? It is “a holistic macro-financial stability framework”. Oh man.
I am not against holism, I should add. But it can be vague as a policy guide. In this case, it means first and foremost that governments should use fiscal policies to offset the effects of loose monetary policy on income and wealth inequality to ensure that after-tax inequality is mitigated. They should also work on regulating the labor market to rebalance bargaining power in favor of workers. And they should invest more in education. These are all good things, of course, but they take us away from the central bank.
Can central banks really only pass the money on to the finance and economics ministries? Not quite: if they’re financial regulators, they can help promote financial inclusion and education, but it takes decades to make an impact. It may also be that macroprudential measures can be used to smooth credit booms and crises, which can reduce the extent of the problem that low interest rates seek to solve. It is too early since it was launched after the financial crisis to know if it will.
The somewhat depressing conclusion is that the current monetary policy framework in the world’s developed economies is likely to lead to greater wealth inequality and that there is little that monetary and regulators can do about it in the short term other than mentioning it in speeches. If the problem is to be resolved, we need finance ministers with a strong political mandate to implement redistributive policies, rather than Fed chairmen and governors prominently featured on this decade’s power lists.
Sir Howard Davies, the first chairman of the UK Financial Services Authority, is chairman of the NatWest Group. He was a director of the LSE and was Deputy Governor of the Bank of England and CBI General Manager.