Eight years ago, Claudio Borio, a senior economist at the Bank for International Settlements, co-authored a paper which warned that the world’s financial system was spinning out of control, due to excess in the complex credit world. At the time, the paper was largely ignored, but now it looks prescient. Given this, investors might do well to look at another paper that Borio has just produced.
He argues that the world’s central banks are currently labouring with an almost impossible task: although the expectations of investors and politicians of these institutions are rising apace, central bankers themselves are at sea in this post-2007 land.
Before 2007, their reputation appeared to be sky high, since central bankers appeared to have produced a Great Moderation of low inflation and growth. But these days, it is clear that many elements of that pre-2007 central bank intellectual model were flawed: central bankers were too obsessed with watching price stability, at the expense of monitoring financial stability; they overestimated the power of short-term interest rates in controlling the economy; and they thought – wrongly – they could shape monetary policy by watching national issues alone.
Borio offers a sensible list of measures that might address these flaws:
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central banks need to adopt a wider sense of responsibility that combines an awareness of monetary trends and financial stability;
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they need to take an international, not national, view of the markets;
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they need better toolkits to monitor financial stability;
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they must take steps to protect themselves from political meddling;
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they need to wean themselves away from the idea that suppressing short term interest rates – via quantitative easing or anything else – will fix the current woes; while this might work during a normal business recession, it does not cure a balance sheet recession.
But most of Borio’s proposed measures are merely pipe dreams. To be sure, some central banks are adopting more flexible mandates that incorporate financial analysis; they are also talking about the need for more global collaboration. But when it comes to practical policies, they are still acting with a domestic intellectual framework and mandate.
And since central banks are still trying to boost the economy by chasing ultra low interest rates – via quantitative easing – they are becoming sucked into fiscal policy decisions. This leaves them politically vulnerable in many ways.
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