Central banking in challenging times

Focus

The essay focuses on the threefold challenge central banks have been facing post-crisis - economic, intellectual and institutional. It pays special attention to central bank independence.

Contribution

The essay examines these issues from a historical perspective. It draws parallels with the first globalisation era that ended in the 1930s with the Great Depression. Many observers regard that historical phase as the heyday of central bank independence. What are the lessons for today?

Findings

The essay argues that central bank independence is closely tied to globalisation. Both spring from the same fountainhead - an intellectual and political environment conducive to an open system in which countries adhere to the same principles and governments remain at arm's length from a market economy. A key way to safeguard independence is to narrow the growing gap between what central banks are expected to deliver and what they can actually deliver. Recently proposed schemes that involve controlled deficit monetisation can be harmful and undermine independence.

Abstract

Since the Great Financial Crisis, central banks have been facing a triple challenge: economic, intellectual and institutional. The institutional challenge is that central bank independence - a valuable institution - has come in for greater criticism. This essay takes a historical perspective and draws parallels with the previous waxing and waning of central bank independence. It suggests that this institution is closely tied to globalisation, as both spring from the same fountainhead: an intellectual and political environment that supports an open system in which countries adhere to the same principles and governments remain at arm′s length from the functioning of a market economy. This suggests that the fortunes of independence are also tied to those of globalisation. The essay then proceeds to explore ways that can help safeguard independence. A key one is to narrow the growing expectations gap between what central banks are expected to deliver and what they can actually deliver. In that context, it also considers and dismisses the usefulness of recently proposed schemes that involve controlled deficit monetisation.

JEL codes: E5

Keywords: central bank independence, globalisation, business cycles, fiscal dominance