John Kay on Central Bank Independence

Faithful readers, I have looked around quite a bit tonight, but I am not coming up with much grist for blogging. Yes, there is a Wall Street Journal front page story that tells us that homebuilders are putting up smaller houses. And there is some chat everywhere about OPEC’s small production increase, one that the markets shrugged off.

When the pickings are slim, there is always the Financial Times. Columnist John Kay discusses how the “BoE should not do City’s bidding,” and his logic seems applicable to most central banks.

In passing, Kay throws out an observation that is often overlooked in the discussion of government intervention in the economy: too many observers assume that the powers that can outlaw, or at least severely dampen, the business cycle. The authorities’ imperfect measurements and limited tools don’t allow for such fine calibration, and even if they did, there may still be hidden costs, such as a dampening of entrepreneurial zeal in growth phases.

From the Financial Times:

Britain has probably been more successful than any other major country in clarifying the elements of traditional central banking. There is an administrative responsibility for debt management, a policy responsibility for interest rates and credit, and a supervisory role for responsible and prudential conduct. Logically these divide between a Debt Management Office, a monetary policy committee and a Financial Services Authority. While there are loose ends to be tidied, the shape of the regime is clear and both the US and Europe could usefully look for lessons.

The implication of this change in regime is that the banking and financial services industries are now in the same position as any other industry lobbying for selective favours. All industries face dislocation from time to time, as a consequence of their own mistakes or new competition, and look for subsidy and protection to give relief. These requests normally receive a dusty answer, and should.

The primary consideration in framing interest rate policy is the control of inflation. Even if crises in debt markets have substantial implications for the wider economy – and it is not yet apparent they do – that does not make a case for central bank intervention. Unless the issue directly bears on the inflation target, the correct response is that such representations should be addressed to the political authorities. Special help for financial services is a matter for politicians to determine and – with difficulty – to defend.

This is the logical consequence of relinquishing the notion that government could, or should, engage in fine-tuning of the business cycle and that commercial banks and their lending policies are, under the aegis of the central bank, agents in the implementation of that process. Financial market liberalisation cannot be undertaken on only one side of the balance sheet. If there is freedom to lend, then there must be freedom to lose money on lending; if there is freedom to construct complex financial instruments no one ought to want, then no obligation to provide a market when people realise they do not want these complex financial instruments after all. There should be no central banker’s put. The price of demonstrating that may be nerve-racking, but there is much more good than harm in the long-term consequences.

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One comment

  1. a

    “There should be no central banker’s put.”

    Let’s extend this logic if we may. Central banks should also not be concerned with volatility. When e.g. Japan says it is not worried about the level of the yen but only about forex volatility, that is allowing traders to amass positions which will earn money because of what the central bank is supposed to do. This is dangerous, because it is creating much greater pressure in the system than would normally be the case.

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