Stop Worshiping Central Banks

Yves here. I doubt that many among our readers hold central banks in high esteem, save perhaps the researchers and data compliers who soldier away and provide useful information and even sometimes provocative analyses. Americans who were paying attention, and it was quite a lot of us even though we continue to be ignored, saw clearly that the banks got ginormous bailouts while little people got at best crumbs and at worst, foreclosures. Even that might have been acceptable if there were serious post mortems, with the boards and executive suites of the miscreants cleaned out, and a serious effort at prosecutions or at least big fines.

However, elites celebrated that central bankers were able to salvage a rotten status quo, even if with baling wire and duct tape. So their stock went even higher in embubblement-land despite being on track to creating another big crisis in less than the normal generation or two time frame.

By Anis Chowdhury, Adjunct Professor at Western Sydney University and University of New South Wales (Australia), who held senior United Nations positions in New York and Bangkok and Jomo Kwame Sundaram, a former economics professor, who was United Nations Assistant Secretary-General for Economic Development, and received the Wassily Leontief Prize for Advancing the Frontiers of Economic Thought. Originally published at Jomo Kwame Sundaram’s website

Preoccupied with enhancing their own ‘credibility’ and reputations, central banks (CBs) are again driving the world economy into recession, financial turmoil and debt crises.

Wall Street ‘Cred’

Most CB governors believe ‘credibility’ is desirable and must be achieved by fighting inflation at any cost. To justify their own more harmful policies, they warn inflation is ‘damaging’.

They argue CBs need ‘independence’ from governments to pursue ‘credible’ monetary policy. Inflation targeting to ‘anchor’ inflation expectations is supposed to generate desired ‘confidence’. But CBs have been responsible for many costly failures.

The US Fed deepened the 1930s’ Great Depression, the 1970s’ stagflation and the early 1980s’ contraction, besides contributing to the 2008-09 global financial crisis (GFC). Hence, CB notions of ‘credibility’ and ‘independence’ need to be reconsidered.

Milton Friedman – whom many central bankers revere – blamed the 1930s’ Great Depression on US Fed actions and inactions. Instead of providing liquidity support for businesses struggling with short-term cash-flow problems, it squeezed credit and economies.

But why did the Fed behave as it did? Some economic historians insist it was “to promote the interests of commercial banks, rather than economic recovery”.

Monetary policy before and during the Great Depression “was designed to cause the failure of non-member banks, which would enhance the long-run profits of the Fed’s member banks and enlarge the [Fed’s] regulatory domain”.

Others concluded, “Federal Reserve errors seem largely attributable to the continued use of flawed policies” to defend the ‘gold standard’, and its poor understanding of monetary conditions.

Central Banks Contractionary

Worse, few lessons were learnt. Instead of protecting the gold standard, or being counter-cyclical, fighting inflation is the new CB preoccupation. Even worse, most CBs now commit to an arbitrarily-set inflation target of 2%, first promoted by the Reserve Bank of New Zealand over three decades ago.

Major CB interventions have caused both economic booms or bubbles and busts or contractions, often without mitigating inflation. Such “go-stop” monetary policy swings have caused asset price bubbles and financial fragility besides sudden contractions.

Ben Bernanke’s research team found the major damage from the 1970s’ oil price shocks was due to the “tightening of monetary policy” response. Other research attributed the 1970s’ stagflation largely to the Fed’s “go-stop” monetary policy, worsened by policymakers’ “misperceptions” and “faulty doctrine”.

Hence, “in substantial part the Great Stagflation of the 1970s could have been avoided, had the Fed not permitted major monetary expansions in the early 1970s”.

Labour Pays

Likewise, Fed chair Paul Volcker sharply raised interest rates during 1979-81 “to a crushing level of nearly 20 per cent by the middle of 1981”.

This precipitated the “ensuing recession that started in July 1981 [which] became the most severe downturn since the second world war”. US unemployment reached nearly 11% in late 1982, the highest since the Great Depression.

Volcker’s actions betrayed the Fed’s dual mandate to pursue both full employment and price stability. First in the Employment Act of 1946, it was re-codified in the 1978 ‘Humphrey-Hawkins’ Full Employment and Balanced Growth Act.

Eventually, the long-term unemployed “became invisible to both the labour market and to policymakers”. Many became deskilled as others fell victim to criminality, substance abuse, and mental illness, even suicide.

The overall health of Americans became “poorer for years as a result of the deep economic recession in 1981 and 1982”.

Sending Global South South

Volcker’s actions caused developing country debt crises, with decades lost in Latin America and Africa. A recent New York Times opinion-editorial warned, “The Powell pivot to tighter money in 2021 is the equivalent of Mr. Volcker’s 1981 move”, and “the 2020s economy could resemble the 1980s”.

Yet, invoking CB credibility, many with power and influence are urging the Fed to stick to its guns with Volcker’s “courage to take out the baseball bat to slam the economy and slay inflation”!

The World Bank warns of dire developing country debt crises following policy-induced recessions. Meanwhile, the International Monetary Fund has warned developing economies with dollar-denominated debt of imminent foreign exchange crises.

Stop-Go New Norm

Fed, Bank of England and European Central Bank policy approaches still justify “go-stop” monetary policy reversals. Resulting booms or bubbles and busts also feature in other recent crises, e.g., the GFC.

Following the 1997 East Asian financial crises, Mexican, Russian and post-US ‘dotcom bubble’ bust, the Fed eased monetary policy too much for too long during the ‘Great Moderation’.

CBs enabled credit expansion in the 2000s, culminating in the GFC. More worryingly, the “near-consensus view” is that independent CBs have failed to achieve – let alone protect – financial stability.

Easy credit and rising stock and housing markets have involved rapid credit and loan growth worsening asset price bubbles. Regulatory oversight became increasingly lax as investors ‘chased yield’. Leverage grew, using dodgy ‘derivative’ products, making proper risk assessment difficult.

Guy Debelle, once Deputy Governor of Australia’s CB, noted, “The goal of financial stability has generally been left vague”. Hence, CBs failed to see significant build-up of financial instability”. Soon after, the Lehman Brothers’ collapse precipitated the GFC.

QE Magic from Bubble to Bust

Governments withdrew fiscal ‘stimuli’ too soon. So, major CBs aggressively pursued ‘unconventional monetary policies’, especially ‘quantitative easing’, to keep economies afloat.

Extraordinary monetary expansion provided vital liquidity, but poor coordination also fuelled asset price bubbles. Thus, unviable enterprises survived, undermining productivity growth.

With less investment in the real economy, supply capacity is falling behind still growing demand. Pandemic, war and sanctions have also disrupted supplies.

Raising interest rates, CBs now race to reverse earlier monetary expansion. Credit contractions are squeezing economies, hitting poorer countries especially hard.

Reviewing historical data, the author of the ‘Taylor rule’ – whom many CBs profess to follow – concluded, “The classic explanation of financial crises, going back hundreds of years, is that they are caused by excesses – frequently monetary excesses – which lead to a boom and an inevitable bust”.

Independence for What?

CB independence (CBI) advocates often claim low inflation during the Great Moderation was due to CB credibility. But inflation in most countries declined from the mid-1990s, with or without CBI.

The alleged causation has been much exaggerated, and is certainly not as strong as argued. Claiming CBI ensures low inflation also denies other relevant variables, e.g., labour market casualization and globalization.

Debelle observed, “How much [low inflation] can be attributable to central bank independence or the inflation target is difficult to disentangle …[Favourable] assessment mostly relies on assertion, rather than empirical proof”.

Milton Friedman argued crisis responses involve inherently political decisions, best not left to the unelected. A modern CB’s “responsibilities overlap with other government functions”. So, CBs must be subject to political authority while maintaining operational independence.

CBI fetishism has also allowed central bankers to ignore distributional consequences of monetary policies. This has often enabled financial asset owners, speculators and creditors. CBI has also meant neglecting development responsibilities.

Emphasizing CBI also implies “a very narrow view of central bank functions”. This has made economies more prone to financial instability and crisis. Clearly, CBI is no harmless ‘elixir’ ensuring low inflation.

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  1. GramSci

    “Worse, few lessons were learnt. Instead of protecting the gold standard, or being counter-cyclical, fighting inflation is the new CB preoccupation.”

    Does anyone else find it odd that even ostensibly ‘progressive’ economists still speak reverentially of the gold standard? I concede that gold has been handed down to the present in the families that have owned mineral rights, mostly to buy sex in marketplaces like the Trump Hotels and the Halls of Congress, but in terms of real value, gold was never anything but a largely useless metal skimmed from the smithies’ slag. One would have thought that after the industrial revolution, WWI, and Hiroshima, economists would have long since acknowledged that real economic value resides in stores of energy: coal, oil, fissile, fusible, and ambient.

    Hmmm. What does this say about economists?

    1. Frank Dean

      I think the author doesn’t intend to “speak reverentially of the gold standard”, but rather to indicate that CBs have replaced one ill-advised obsession with another. Perhaps it isn’t worded as clearly as it might be.

      Most economists would agree with Keynes in describing it as “a barbarous relic”.

      1. Anthony G Stegman

        Gold has always served as a store of value going back to time immemorial. Keynes may have thought of gold as “a barbarous relic”, but what would Keynes replace it with? We know the many problems associated with fiat money. There must be something to back currencies aside from mere “faith”.

        1. Yves Smith Post author

          Gold has no intrinsic value. This is simply a convention, the same way fiat money is. The Mayans used feathers. Anything can serve as a store of value: real estate, diamonds, art, antique cars, baseball cards. That does not mean it is or would be suitable as money.

          Keynes did have a proposal, bancor, and I suggest you study up on it rather than convey misinformation.

          1. digi_owl

            Interesting how bancor was dismissed at Bretton Woods, yet the IMF has to a large extent quietly implemented it as special drawing rights.

          2. Bart Hansen

            One problem with the gold standard is that that its supply could not be expanded quickly enough to support the Vietnam War and later our Endless Wars.

            1. digi_owl

              While i am no goldbug, i would see that as a good thing.

              That said, not being able to expand to cover wars also meant it could not expand to cover the economic activity of an industrialized world.

              And that is why i have no love for bitcoin, as it is basically trying to emulate a gold standard using cryptography.

              That said, the idea of the blockchain as a ledger is starting to grow on me. If implemented right, and maybe something as “dumb” as the dogecoin is more in line with that, it can enable microtransactions online without having to expose credit card info everywhere.

              I am somewhat curious if that is what Brave Software is trying to do with their Basic Attention Token. Sadly thus far they do not seem to allow us to outright buy tokens.

              1. Adam1

                Be careful what you wish for. Any and all monetary systems have to have a way of adjusting when things in the system become unbalanced which WILL happen.

                The gold standard was nothing more than a fixed foreign exchange regime which meant that when there were international imbalances it required domestic adjustments to unwind the imbalance – usually meaning high interest rates and high unemployment. If you were wealthy and isolated from unemployment the benefit was your trips to Europe and your French wine by the case didn’t cost you anything extra.

                With a Fiat currency and floating exchange rate when international imbalances occur the currency adjusts although your French wine likely gets more expensive. The benefit is when the business investment cycle wanes your can spend your way back to full employment. Of course you can also fund a lot of useless wars, but that’s a political choice that is chosen. Likewise you can choose to allow high unemployment so that French wine doesn’t get more expensive – but these are options that are available to us.

          3. DJ's Locker

            The Chinese and the Russians seem to believe that gold has intrinsic value, given the rate at which they have been accumulating it.

            Managing international trade and currency appreciations and depreciations with the bancor was perhaps not Keynes best idea, but it has merit for settling international trade balances. Interestingly, I understand that bancors would initially be obtained in exchange for gold, so in a sense they were gold backed. That said, they could not be exchanged back for gold, so the ever brilliant Keynes may have foreseen the problem that eventually led to Nixon shutting the gold window in 1971. I suspect the Chinese and the Russians have been accumulating gold with a view to create a gold backed “bancor” for settling international trade balances and that we will see it before too long.

            1. Yves Smith Post author

              The fact that someone is buying an asset does not prove they believe it has intrinsic value. Stocks trade in huge volumes daily yet individual shares of stock have no intrinsic value. They are a very weak and ambiguous promise. You have the right to receive dividends if the company makes money and the executives and board decide to pay them, and you have a vote on a few matters that can be diluted at any time.

              As for gold, it does has a floor of some sort due to its use in industry and for jewelry. But that floor can be low. For instance, women in Vietnam often had gold bead networks as a way of storing their wealth. During the Vietnam war, women would have to use their beads to buy food. The prices they got were vastly below “market” prices.

          4. dean 1000

            Gold conducts electricity really well. Look at the gold connectors on expensive HDMI cables. Conductivity is its only intrinsic I’m aware of. Most of those connectors are just gold plated.

            1. caucus99percenter

              Malleability is also intrinsic and is so extreme in the case of gold that the metal can be “hammered” into incredibly thin sheets — gold leaf.

            2. DJ's Locker

              Silver and copper are better conductors. Gold’s advantage is that it does not tarnish, so it conducts well for longer – hence only gold plating is required.

        2. eg

          Can you eat gold, Anthony? Even the Greeks of antiquity knew better than to fall prey to its false allure.

        3. Korual

          Aside from mere faith?

          Like taxation and the monopoly of violence?

          If you want to avoid your taxes and evade jail time, you will need expensive lawyers.

          Alternatively, simply get some currency and pay your taxes.

  2. Antagonist Muscles

    Perhaps we should update the phrase “baling wire and duct tape” to reflect modern day practicality. It’s rather embarrassing how much duct tape I use around the house to temporarily fix things. Then I remove the temporary status, and the duct tape stays. In contrast, I don’t even own baling wire. I would imagine baling wire is so sharp and dangerous that safety gloves and pliers are necessary when working with it. Is baling wire practical in a pinch?

    Because duct tape is so versatile, I keep a roll in my emergency evacuation backpack. Bundling things up with rope is also enormously practical. Therefore, paracord goes in my emergency backpack. One can even buy paracord and duct tape in attractive colors to not draw attention to their (typically) impromptu usage. “Paracord and duct tape” is a phrase I champion instead of “baling wire and duct tape.”

    1. Jeremy Grimm

      The hero in Andy Weir’s book the “Martian” espoused belief that duct tape should be worshiped as a god.

      Where I live now, baling wire is not uncommon and most of the things around where I live are best handled with gloves to avoid thorns or splinters or other unpleasantries. I do agree and sympathize with your assessment that baling wire, to which I might bubble gum, has grown uncommon in urban surroundings. “Paracord and duct tape” — at least to my ear — lacks the cadence and music of “baling wire and duct tape” or the older “baling wire and bubble gum” with its pleasing alliteration. Besides, baling wire like flour bag-sealing string is not so pricey as paracord.

    2. David S.

      I’m thinking more of hay bales, bound with pliable wire or sometimes rope. If you are a consumer of hay bales, you collect baling wire and use as needed.

      1. Revenant

        The equivalent UK phrase is bailer twine. Famously used for holding up farmer’s trousers. Tough, thin, coarse-stranded nylon cord used for tying hay bales.

    3. Dave in Austin

      I think you are confusing baling wire with barbed wire. Baling wire is not “sharp and dangerous”.

  3. Pinhead

    Monetary policy is a powerful but crude tool. Fiscal policies – and the plural is very important – are largely in the hands of legislatures that cannot respond to the economy’s needs on a timely basis.
    Sooner or later the economic responsabilities of these institutions have to be merged and reformed to achieve goals that are almost univeraly sought: stable prices including asset prices, maximum growth with low levels of unemployment, gradual but consistent decline in economic inequality. Further down the road comes integrating much of the world into a single monetary system.

    1. Anthony G Stegman

      Europe has tried the single monetary system with very mixed results. Single monetary systems can only work in environments with similar productivity, similar laws, similar lifestyles, similar values. In other words, a largely homogenous world. This is very far from what exists today.

      1. Yves Smith Post author

        No, we have a single monetary system in America and we have very different productivity and values and lifestyles in different area. The EU’s legal system has fewer frictions (now that the common law UK is out and everyone else is on civil law) than our state/federal system. And the UK was not in the Eurozone.

        The issue with the Eurozone v. the US is that the US has enough spending at the federal level to buffer economic differences between wealthy and poor states. The rich states like California and New York subsidize Mississippi. By contrast, in the EU, Germany does not subsidize Greece.

        1. Revenant

          With respect Yves, I disagree in part.

          The USA is remarkably homogeneous, far more so than Europe. Look at the divergences in chocolate, potato, beer and wine consumption within Europe. Or, more prosaically, in total factor productivity, between France and Bulgaria. The German rental market versus Italian owner-occupation without mortgages and Swiss owner-occupation with mortgages. The Rheinland model of savings banks. The Scandi model of lower capital taxes and high labour taxes and welfare. The (until recently) long traditional of Communist local government representation in France and Italy. The historic colonial ties of UK, France, Netherlands, Spain to very different parts of the world. The EU is very much not homogeneous. It is also very local: Italians will not leave their home city!

          Whereas the US has a uniform legal system (ignoring Louisiana), with minor local variations, a single dominant language and exceptional labour mobility and working conditions Europeans laugh at (next to no paid holiday entitlement, maternity leave etc.).

          Having said that, I would agree with you that the US is not a natural single currency zone and it is only made to work by Federal action. It took a civil war to impose a single currency on the agrarian south and the industrial north. It took the New Deal and WW2 to develop the sunbelt.

          The problem in Europe is that not only does it lack these advantages, of a single language and culture and labour mobility and popular taste but it lacks a common legal and political framework fore reaching and it lacks a transfer payment system (except for farmers!). But it has hard to imagine what level of transfer payments or cultural reconditioning would make the Euro suitable for southern Italy and northern Italy, given they barely fitted inside the Lira with a single government trying to balance the zones. Even peaceful Switzerland is a seething nest of cultural resentments, between language groups and religions and social contracts.

          Mr Stegman is right when he talks about values. Without a single set of ethical values, a transfer union cannot work. The recipients and the benefactors must agree on the propriety of the transfers or they will ultimately be a source of resentment, too little on one side and too large on the other. The German Ordoliberals do not share the same values as the Mezzogiorno.

          Oh, and following the UK’s departure, the EU still contains common-law countries: Ireland, Malta and, in key domains (banking etc.), Cyprus.

          1. Yves Smith Post author

            You have not spent time in the Deep South. Consumption pattens are very different here from blue cities. Tell me how many people in the North eat fried pork rinds, fried okra, or Hoppin’ John.

            The data is obscured by the fact that “blue” states are actually blue cities that are big enough to dominate or at least substantially sway the misleading state-level view. Look at the pro v. anti gun, or pro v. anti abortion, or pro v. anti gender reassignment for kids split among voters across the US. As I recall Europeans were shocked by what they saw as a retrograde US decision.

            Some of our aides had never left Alabama and were only interested in visiting a big US city or two, so there’s provincialism here too. If your only reliable safety net is family, you won’t stay too far. I also know people in their late 40s in old Yankee Maine who have lived only in the town where they grew up and are not interested in leaving. They may not be as loud about their loyalty as your Italians, but they are not going anywhere.

            Similarly, I am not sure if the EU has rule of law gaps the way we do. There are towns in New Mexico where the IRS does not dare go (this from the former DA in a very tough and large-ish East Coast city), not for what you’d expect, gang dominance, but that they are known to have extreme anti-government right wingers there.

            How about the unorganized territory of Maine, where (as Lambert calls them) beardos roam the earth? They look like Chechen soldiers kitted out in worn LL Bean attire:

            The unorganized territory (UT) of Maine is that area of Maine having no local, incorporated municipal government.

            Duties related to providing services and property tax administration in the UT is shared among various state agencies and county government. The Maine Legislature serves as the “local governing body” for the UT, as it annually reviews and approves the various budgets from state agencies and county government necessary to provide services and property tax administration in the UT.

            The unorganized territory consists of 429 townships (including the Baxter State Park area), plus many coastal islands that do not lie within municipal bounds. The UT land area is slightly over one half the area of the entire State of Maine. Year round residents number approximately 9,000, with many more people seasonally residing in the UT.


            I would assume that Maine has some success in collecting property taxes. But income taxes? I am pretty sure there are no banks up there. It appears the UT gives scholarships to those who want to go to school….presumably elsewhere.

            As I am seeing from probate, there are also substantial differences in practice in different US states (my friend in other states are pretty shocked at some of the views of the court here). Alabama also allows for only state chartered banks, and as a result, consumer protections are much worse than in the rest of the US. The only reason we wind up getting better is most of the banks are regionals who got an Alabama charter, and it’s not worth the bother to take advantage of the extremely lax supervision. The flip side is my local bank had been “unable” to deliver me duplicate copies of records OR even get me set up for online banking (2 attempts at the branch failed).

            As we discussed in the mortgage crisis, there are substantial differences across the US into the property rights of mortgage borrowers (title theory v. lien theory) which made a very big difference in foreclosure defense. Tenant rights also vary a lot across the US.

  4. Lou Anton

    “Extraordinary monetary expansion provided vital liquidity, but poor coordination also fuelled asset price bubbles. Thus, unviable enterprises survived, undermining productivity growth.”

    Is there any real evidence for this? I know QE added trillions of bank reserves denominated in USD, but what’s the mechanism through which that let to asset price bubbles? Bank reserves (the thing that QE adds to ban balance sheets when buying treasuries from them) don’t or aren’t supposed to leak into the real economy.

    Maybe some of the great commenters here that work in banking can explain (always grateful BTW!)?

    1. digi_owl

      I think there was a comment somewhere on here recently about how each time the Fed would buy an “asset” off the banks, the banks would turn right round and buy a new such asset off the market. This with the expectation that they could turn right round and sell it on to the Fed once again. Effectively QE thus created a cobra effect on the asset market.

    2. Objective Ace

      In addition to what DO said, banks can lend out a multiplier — something like 10x — of their reserves. Larger reserves equals more money lent out/leaking into the real economy*.

      *I’m not sure I would label it the “real economy” though. Inflation was low. It was just asset prices that were going up because the people who had access to this new money tended to hoard it rather then consume

  5. eg

    Central banks are, by design, aristocratic institutions inimical to labour. As such, “independence” means the highest possible degree of freedom from democratic oversight to pursue policies favouring propertarians, rentiers and oligarchs.

  6. JimmyV

    I used to not be in the end the Fed camp, but over recent weeks I’ve been going back and examing their arguments more thoroughly. I’m becoming increasingly convinced that the best thing for the us economy would be to get rid of the Fed and return any important function they do to the authority of the Treasury department. Where the people could have more direct political oversight.

      1. dean 1000

        The pyromaniacs have the matches now. They have been crashing economies at least since the tulip mania. But it is not called inflating the economy down the tubes.

  7. Max

    Why is the first central bank in democracies PRIVATE?

    The First Bank of the United States (1791-1811) was private. Who were its owners? So we had the American revolution to get a private central bank and private monetary system?

    The Bank of England was private, when founded in 1694, after the English Civil War. It was private all through the era of the British Empire. It was nationalized in 1946.

    The Bank of France was private, when founded in 1800 after the French Revolution. So French fought a revolution to get democracy and a private central bank – private monetary system, controlled by whom? New Financial Rulers?

    Most revolutions are financial revolution.

    Who has been driving the creation of private central banks, private money, democracies/republic,… all over the world?

    Please name a democracy that isn’t a suzerainty (vassal). Who controls democracies?

    The façade of the MYTHS such as democracy/republic, capitalism, rule of law, independent media,…is unraveling.

    The Financial Empire’s LIE will end!
    LIE ~ Lying, Imperialism & Enslavement

  8. Memento mori

    I tried to follow Yellen when she was at the Fed but after 5 min it was impossible for me to concentrate on what she was saying. Then I heard that she got $7million in speaking fees from wall st doing 40 min speeches. If there are people paying that kind of money and enduring her for 40min they deserve to be rich. I guess that is why I am going to remain poor.

  9. Gulag

    An accelerating danger is that central banks risk losing their independence to financial market participants. As Carolyn Sissoko has argued, with Central Banks increasingly embracing the “prop trader of last resort” role in sovereign debt markets, central banks tend to incentivize sophisticated market participants (like Black Rock) to create products that rely on central bank intervention as a backstop. This activity is likely to ensure that sophisticated financial market participants do not lose money.

    Is moving this type of risk back into the banking system where loses on private sector loans are borne by the private sector and not the Central Bank, now the best option?

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