Opinion

Central banking’s brave new world

Ever since the 2008 financial crisis, central bankers have been busy developing new policy instruments to fight fires and ward off emerging threats. Nonetheless, many secretly dreamed of returning to the good old days of cautious conservatism (with financial stability taken seriously).

By: Date: February 24, 2021 Topic: Global Economics & Governance

This opinion piece was originally published in Project Syndicate.

Twenty years ago, central bankers were proudly narrow-minded and conservative. They made a virtue of caring more about inflation than about the average citizen, and took great pains to be obsessively repetitive. As future Bank of England (BOE) Governor Mervyn King said in 2000, their ambition was to be boring.

The 2008 financial crisis abruptly dashed that objective. Ever since, central bankers have been busy developing new policy instruments to fight fires and ward off emerging threats. Nonetheless, many secretly dreamed of returning to the good old days of cautious conservatism (with financial stability taken seriously).

But recent announcements by the US Federal Reserve and the European Central Bank suggest that there is no going back. Central bankers are now keen to take on responsibility for policy objectives they previously shied away from – in particular, tackling inequality and climate change.

Start with inequality. If there was a red line in the delineation of responsibilities between elected and unelected officials, it was that distributional, give-and-take choices belonged solely to the former.

Yet, the Fed has announced that it will now pay attention to “shortfalls” of employment from its maximum level, instead of “deviations,” as previously. According to Chair Jerome Powell, the main reason for this change is the realisation that a tight labour market benefits low-income communities and ethnic minorities. Only when the aggregate unemployment rate is very low do those on the fringes of the labour market benefit from significantly better access to jobs and higher wages.

Policymakers have long known that a high-pressure economy benefits the unskilled and minorities, and the Fed is special in having a dual congressionally assigned mandate of achieving both price stability and full employment. What is new is that instead of defining its own tasks in purely macroeconomic terms, the Fed has now indicated a willingness to take part in a collective anti-poverty effort.

The reason, the Fed says, is that listening to citizens has convinced it of the heterogeneity of the US labour market and the benefits of testing the downward limits of unemployment. But in yesterday’s world, the Fed was proud to be insulated from politics and therefore not to listen to citizens.

The ECB has not completed its policy review yet. But it is unlikely to draw the same conclusions. Whereas the Fed can regard higher inflation in Colorado as an acceptable price to pay for a tight labour market in Mississippi, the ECB cannot operate the same way. European countries have limited appetite for such solidarity. Instead, what European central bankers are increasingly considering is support for climate action.

The ECB is not entering new territory here. In a landmark 2015 speech, then-BOE Governor Mark Carney emphasised the financial-stability risks arising from climate change and the responsibility they imposed on regulators. This insight made climate risks a topic of concern for financial-system supervisors.

But today’s eurozone central bankers are going further. ECB President Christine Lagarde has said she intends to “explore every avenue available in order to combat climate change,” while fellow board member Isabel Schnabel has alluded to excluding brown bonds from monetary-policy operations. And Banque de France Governor François Villeroy de Galhau has suggested applying a carbon-related haircut to assets accepted as collateral.

Favouring green assets would imply a departure from the market neutrality that ensures maximum monetary-policy effectiveness. It would also cross another red line by turning the ECB into the implementer of a policy for which it has no other mandate besides the general clause that, subject to maintaining price stability, the central bank supports the policies of the EU.

To orthodox critics, this is anathema. The Hoover Institution’s John Cochrane (who is no climate-change denier) accuses the ECB of engaging in self-defined mission creep. Bundesbank President Jens Weidmann is notably unenthusiastic. And the Fed itself is much more cautious than its European counterpart regarding climate action.

It is no accident that both the Fed and the ECB are venturing into new terrain. With inflation having vanished, at least temporarily, neither institution wants to be the high priest of a forgotten deity. Their quasi-parallel moves are indicative of the tectonic shifts currently affecting civil societies, and illustrate the desire of independent policy institutions to remain attuned to social preferences in order to retain their legitimacy.

But these moves entail risks. The Fed is now caught in a bind between its own commitment to testing the lower limits of unemployment and the disregard of President Joe Biden’s administration for the dangers of providing too much economic stimulus. It may have tied its hands at the wrong moment.

As for the ECB, the financial-stability justification for greening its policies is only partially convincing. Green bubbles are a threat, too. And there is also financial-stability risk in extending credit to firms that invest in decarbonised technology on the assumption that governments will set the carbon price high enough to make these investments profitable in the future. Governments often fall short of fulfilling their promises.

This is not to say that central banks should do nothing. Inequality and the climate emergency are immense challenges that policy institutions cannot overlook. But explicitly amending the central banks’ missions would be preferable to letting monetary policymakers decide how their tasks should evolve.

This especially applies to the ECB, which has an extremely narrow price-stability mandate under the EU Treaty (the Fed, in addressing inequality, arguably remains within its mandate). Because EU treaties are so difficult to amend, the ECB is right to explore and experiment. But decisions about what aims the institution serves should ultimately rest with its principals – the member states.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint.

Due to copyright agreements we ask that you kindly email request to republish opinions that have appeared in print to [email protected].

Read article More on this topic More by this author
 

Opinion

More Europe or less Europe?

Europe is often a ship with multiple captains. The boat moves forward in calm seas, but when the slightest wind puts it off course, it is not easy to steer that boat. It is not so much a question of more Europe rather than less, but of achieving ‘one Europe’. A ‘more-or-less Europe’ is an invitation to go nowhere.

By: Maria Demertzis Topic: European Macroeconomics & Governance Date: April 14, 2021
Read about event More on this topic
 

Past Event

Past Event

An alpine divide? Comparing economic cultures in Germany and Italy

A discussion of Italian and German macro-economic cultures and performances.

Speakers: Thomas Mayer, Patricia Mosser, Marianne Nessén, Hiroshi Nakaso, Francesco Papadia, André Sapir and Jean-Claude Trichet Topic: European Macroeconomics & Governance Date: April 13, 2021
Read article More on this topic More by this author
 

Opinion

It’s time for a green social contract

The green transformation will have far-reaching socio-economic implications. Action is needed to ensure domestic and international social equity and fairness.

By: Simone Tagliapietra Topic: Energy & Climate Date: April 12, 2021
Read article More on this topic
 

External Publication

Wealth distribution and social mobility

This report explores the distribution of household wealth in the EU Member States and analyses the role of wealth in social mobility.

By: Zsolt Darvas and Catarina Midões Topic: European Macroeconomics & Governance Date: April 1, 2021
Read article Download PDF More by this author
 

Working Paper

The unequal inequality impact of the COVID-19 pandemic

Less-educated workers have suffered most from job losses in the COVID-19 pandemic, and it is quite likely there was a significant increase in European Union income inequality in 2020.

By: Zsolt Darvas Topic: European Macroeconomics & Governance, Global Economics & Governance Date: March 30, 2021
Read article More on this topic More by this author
 

Opinion

Financial literacy and the fearless woman

Many gender gaps persist, but an important one that puts women in a very disadvantageous position is the gap in financial literacy.

By: Maria Demertzis Topic: European Macroeconomics & Governance Date: March 30, 2021
Read about event More on this topic
 

Upcoming Event

May
25
15:00

The work of the future: How are new jobs created and what are the implications for labour markets?

Join us for a presentation of 'New Frontiers: The Origins and Content of New Work, 1940 — 2018' by David Autor (MIT and NBER) and the findings on the source of 'new work' followed by a discussion with an invited panel of academics and policy makers.

Speakers: David Autor, Maarten Goos, Barbara Kauffmann and Georgios Petropoulos Topic: Innovation & Competition Policy
Read article More on this topic More by this author
 

Podcast

Podcast

Gender gap in financial literacy: a lack of knowledge or confidence?

“If women and girls are fearless, they will benefit by becoming more financially independent, more financially secure, more in control of their future and society will benefit.”

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: March 24, 2021
Read article More on this topic
 

Blog Post

How has COVID-19 affected inflation measurement in the euro area?

COVID-19 has complicated inflation measurement. Policymakers need to take this into account and should look at alternative measures of inflation to understand what is actually happening in the economy.

By: Grégory Claeys and Lionel Guetta-Jeanrenaud Topic: European Macroeconomics & Governance Date: March 24, 2021
Read article More on this topic More by this author
 

Opinion

Central banks don’t have to pick winners and losers to fight climate change

Disclosures and financial regulation don’t get enough respect as tools to reduce emissions.

By: Rebecca Christie Topic: Finance & Financial Regulation Date: March 11, 2021
Read article More on this topic More by this author
 

Opinion

資產泡沫無益於疫情後的經濟恢復

新冠疫情帶來的全球經濟危機可以說是公認近些年來最嚴重的,但相比於程度與之最相似的1929年經濟大蕭條,二者對資產價格帶來的影響卻截然不同。

By: Alicia García-Herrero Topic: Finance & Financial Regulation Date: March 3, 2021
Read article More on this topic More by this author
 

Podcast

Podcast

Can central banks save the planet?

“We are not going to lead our society to a low-carbon economy by continuing to finance the status quo. “

By: The Sound of Economics Topic: Energy & Climate Date: February 24, 2021
Load more posts