This week saw a flurry of activity from central banks, with the US Federal Reserve, the European Central Bank and the Bank of England all increasing interest rates and giving their opinions on what to do next. It looks like 2022 is the year that the world called time on central bankers, revealing a disturbing lack of competence at the heart of our economic system. How the mighty have fallen.
A central banker on a chat show is a new departure. In late October, Christine Lagarde, the head of the ECB, appeared on RTÉ’s Late Late Show. When technocrats are on TV, it’s more likely to be in an obscure parliamentary committee on a weekday afternoon, not prime time, after the watershed, on a Friday night.
Central bankers have become celebrities. Think about the lavish praise and glowing profiles heaped on Mario Draghi. Ms Lagarde, an international career operator in the classic haute-technocrat French mode, when asked about the surge in inflation, responded to Ryan Tubridy with a rather worrying answer: “Inflation came out of nowhere.” You’ve got to do better than that.
A charitable explanation for this lapse of judgment and failure to come up with a plausible story could be that what she meant to say was inflation in Europe is largely an energy affair and that Vladimir Putin’s invasion of Ukraine triggered an energy price crisis. In fairness, few outside the American state department (which appears to have a mole inside Putin’s head, so accurate is its intel) predicted the invasion. However, the boss of the central bank must exude confidence. A Gallic shrug of the shoulders doesn’t cut it.
Ms Lagarde’s hauteur only reinforces that 2022 will be remembered – in economic circles at least – as the year the world’s central bankers were exposed as having feet of clay. Will 2023 be the year that central bankers fall to earth?
After 30 years reigning, almost unopposed, atop global economic policymaking, we now know that central bankers understand less than we thought they did.
Throughout much of modern economic history, since 1900, there has been a conflict at the core of policymaking between central bankers and government. The issue at stake is who controls money. Is there anything more consequential? The set-piece battle centred on the observation that money makes the world go around. Governments want the world to spin more quickly, central bankers want to slow things down.
Governments seeking re-election will always run the economy “hotter”, risking inflation but bragging about how brilliant their economic management is, based on higher levels of employment, wages and growth. The unelected central banker has no compulsion to chest-thump about growth. More concerned about resulting inflation, the central banker’s weapon is raising interest rates to cool things down. The more macho of that tribe revel in the cliche about being “the person who takes booze away just when the party is getting going”. Policy is a tug of war between these two powers: government with its foot on the economy’s accelerator, the central bank with its foot on the brake.
After the second World War, governments exercised control over central banks, more or less telling them how much money to print and what the rate of interest should be. If the government spent too much, there was always the option of having the central bank buy the state’s IOUs, giving the government a free lunch. You can do that sort of thing when there are capital controls. By the 1970s, inflation, having been dormant for decades, took off and the central bankers, sitting on the sidelines, cried “told you so” while pointing at profligate governments.
The central bankers, aided enormously by a swing to the right in the economics profession, maintained that if control over the money reverted to them, their superior understanding of the economy and the inner workings of monetary policy would mean lower inflation.
Constant agitation for independence bore fruit throughout the 1980s, and one by one central banks became independent. The technocrats had control of the most important substance in the economy, money, giving technocrats enormous power over the electorate, yet they were accountable to no one.
Obviously, the most extreme example of this remoteness is the ECB, where technocrats are not even answerable to a parliament. Interest rate decisions in the euro zone affect the lives of hundreds of millions and they were being taken by remote functionaries. In time, they increased their powers to policing all areas of economic policy from taxation to government spending, setting limits on government debt.
During Ireland’s bailout negotiations, our government was even offered a deal by such technocrats which proposed that Ireland raise its corporation tax in exchange for a few percentage points shaved off the bailout loan. For many, such intrusions – particularly when the 2008 crisis was the direct result of central bank regulatory incompetence – was a step too far. Yet as long as inflation stayed low, the central bankers had a trump card allowing them to claim credit for – as Boris Johnson would later claim – “getting the big calls right”.
Sceptics point out that the low-inflation period of the past 25 years is due to a combination of factors that had nothing to do with central bankers at all. The emergence of China into the global economy doubled the global workforce, pushing down wages. Energy prices have been low relative to the 1970s, keeping a cap on costs, and engineering innovation was driving down the costs of using technology. Consider how dependent you are on your phone now for both work and play. Contrast that with just 10 years ago and contrast the price of telecoms now with then. All these structural factors drove inflation down and none of them had anything to do with central bankers.
In 2022, as inflation took off, naturally people looked to the omnipotent central bankers for a solution. But they had no answers bar precipitating a recession using the blunt instrument of higher interest rates. The emperor’s new clothes come to mind. Inventive anti-inflation strategies are coming from certain governments such as Germany’s, which is using price caps to reduce energy price inflation, subsidising German industry.
At a global level, the gas and price cap on Russian energy is coming from governments, not central bankers, who are in a bind because, having blown up an asset price bubble with easy money, they can’t now deflate that bubble too quickly without risking another 2008-style global financial crisis.
We are already seeing 2008-style asset price falls in tech and crypto markets. Could we see contagion in the general economy? Quite possibly. The last time, the viral super spreaders were the banks. Could they afflict us all again?
What now for central bankers? It’s quite likely that the pendulum will swing against central bank independence in the next few years and governments will try to wrest control of money from the technocrats. Maybe that will be Lagarde’s legacy. She may be regarded as the last of her kind. A policy swing like that would not be without its casualties. Expect the 30-year settlement at the heart of the euro zone, in which Italy and France accept German dominance in the field of money, to be tested.
If central bankers want to keep their privileged position while the average politician gets savaged on a daily basis, they’ll have to come up with better lines than “Inflation came out of nowhere”. Power without responsibility is the most dangerous dominion.