Robert Pringle's Viewpoint: A pride of central banks

Given the barbed criticisms currently being thrown at central bankers by the media and politicians in many parts of the world, it would be understandable if, on their way to work in the morning, they were to mutter a dictum favoured by Montagu Norman, the former eccentric governor of the Bank of England:

"The dogs may bark, but the caravan moves on".

Central bankers have to deal with the world as it is, observe how it evolves and act accordingly. They don't set the rules of the game, nor do they decide the destination of the 'caravan'. I have argued in previous columns and in my book, The Money Trap, that the international monetary anti-system (to borrow Jacques de Larosière's phrase) makes it very difficult for central bankers to deliver financial and monetary stability in the long run. But their role is to operate this flawed system as best they can – and in any case with dedication and integrity. In general, they have succeeded in this task. It is not their fault if the system itself is, to use US consumer champion Ralph Nader's phrase, "unsafe at any speed".

By their record of success and their credibility they postponed the great reckoning (otherwise known as the Great Recession) as long as possible – possibly allowing imbalances to grow and making it, in the end, even worse. Now, entering another cycle, they have been equipped with new weapons and responsibilities to promote financial stability. Will they use them in time? Or will they again allow imbalances to build up?

The recent record

In the UK, governor Mark Carney is preparing public opinion for action to cool the housing boom. As Charlie Bean, a retiring deputy governor, puts it, the low level of volatility and search for yield, taken in isolation, are "eerily reminiscent of what happened in the run-up to the crisis". What to do? Yes, monetary policy ought to take greater account of stability concerns, but, as Bean acknowledged, it would be a "brave" central banker who deliberately plunged the economy into recession in order to prevent a future financial crash.

In Japan, the media hype that greeted the political appointment of Haruhiko Kuroda as governor last year has dwindled as the reality of Japan's intractable problems sinks in yet again (a similar cycle of hype and disillusion took place following the appointment of Toshihiko Fukui to succeed Masaru Hayami 10 years ago).

In Sweden, central bank governor Stefan Ingves is standing his ground despite political pressure to stimulate further and the criticisms of academics led by Lars Svensson, who left the Riksbank only last year after serving six years as deputy governor. In Frankfurt, Mario Draghi is not exactly dragging his feet, but is clearly taking his time before placing the punchbowl back on the table. Again, he's coming in for his share of the brickbats.

In the euro area periphery, also, the central bankers have proved their worth. In Greece, for example, the central bank under George Provopoulos helped to avert a full-scale run on its banking system during the country's sovereign debt crisis, thereby also averting an exit of Greece from the euro. Also, the banking system has been restructured. Markets have stopped obsessively focusing on 'Grexit', and the people who confidently predicted it have been proved wrong.

Turning to emerging markets, in India, Raghuram Rajan is hopefully secure in his position as governor of the Reserve Bank of India (RBI). Were the incoming government led by the populist Narendra Modi to be so unwise as to remove him, or put undue pressure on the RBI to cut rates further, inward investment on which India depends would collapse. Yet the message that Rajan will give to the government and new finance minister (yet to be appointed) will not be to their liking: the room for manoeuvre is strictly limited. The RBI hopes that its efforts to promote stability are supported rather than, as has been the case up to now, continually undermined by the politicians; and if the 'feel good' factor does prompt the private sector to raise investment spontaneously, all to the good. But does the new political leadership understand that the central bank has no magic wand?

In Nigeria, the central bank has come out well from the clash over the 'missing billions' of oil revenues – somebody had to expose the scandal (see the informative leader in the current issue of Central Banking). In China, the People's Bank of China continues to support gradual and cautious market liberalisation – a long-term reform agenda in which it has been a key figure (as brought out well in The Rise of the People's Bank of China, by Stephen Bell and Hui Feng).

Central bankers in emerging markets have faced up bravely to the huge tides of capital flowing in and out of their markets as investors globally respond in a flash to the latest signals from Washington, Frankfurt and London. Leaders such as Rajan have begun to articulate a reasoned criticism of the system that inflicts such punishment on so many relatively poor and defenceless people. In the Philippines, the central bank has set a good example of capital flow management while avoiding the trap of fussy and illiberal physical controls.

A healthy cultural change

What do these points suggest for the further evolution of central banking?

In 1996 I wrote a paper for a World Bank workshop on 'The Changing Culture of Central Banking'. I contrasted the ‘traditional culture' with the ‘emerging culture'. The former was characterised by diffuse objectives, secretiveness, hierarchical structure, a domestic focus, a low public profile, and a low degree of independence. By contrast, I characterised (in 1996) the ‘emerging culture' as including a focus on core activities, notably price stability, transparency and accountability, objective performance criteria, internationalism, a high public profile and a significant degree of independence.

The change of culture has endured, matured and proved its worth. At a time when public confidence in institutions of all kinds has declined, the central bank remains often the most respected institution in its country. Broadly speaking, credibility, though damaged in the crisis, has been retained, though it has to be continually fought for. In general, they manage national assets, including external reserves, in a much more professional way than before. They contribute hugely to a nation's credit standing; they are to a large extent, the 'face' a country shows to the financial markets.

Central banks have, with few exceptions, delivered a reasonable approximation to price stability. They have laid the basis for a gradual recovery. They have shown governments that there are no short cuts to growth. They have explained the need to tackle structural problems and the case for fiscal responsibility. All this represents progress.

Challenges

Central banks in emerging markets face an even greater set of challenges than those in developed economies. They will play an important role in building the financial infrastructure needed to meet the exponential rise in the demand for financial services and financial intermediation expected over the coming 20 years. They have to support the fight for inclusion – as the RBI for example has done in India – and in raising standards of public education in personal financial management; they have challenging roles in overseeing revolutions in payments systems, and in fostering the responsible growth of microfinance, and encouraging new entrants into the banking sector often dominated (as in India) by moribund state-owned 'dinosaurs' loaded with non-performing loans.

What are the new risks they face? Philip Turner has provided a useful check list for developed-country central banks as they attempt to normalise their balance sheets. I myself feel that forward guidance has been a damp squib. They have yet to show they can successfully combine macro-prudential supervision, micro supervision and monetary policy (NB Mark Carney: what's the point of all these new instruments if you seem afraid to use them?).

In emerging markets, there are the sad cases of Venezuela, which is in an anarchy induced largely by currency mismanagement, and Argentina, looking dangerously close to following suit. These examples underline the importance of good central banking. They illustrate only too vividly what happens when political leaders destroy the integrity of the central bank. By contrast, the central bank of Paraguay has recently been praised for its modernising efforts, including the introduction of a new payments platform and the release of MPC minutes.

Beware crony capitalism

More generally, I would point to another growing risk. As central banks come closer to the commercial sector, exercising powers such as the granting and withdrawal of licences, and become more involved in decisions determining the livelihood of individuals, there must be a growing risk of 'crony capitalism' at best and outright corruption at worst.

This can take many forms – many of which are hard to detect or prove. The generation of central bankers that believed good economics lay at the heart of what they had to do may never have learnt the different kind of toughness, discipline and professionalism needed. With sufficient training, they can resist undue influence of the financial sector while ensuring they are closely in touch with markets. But it won't be just a matter of common sense; procedures, guidelines, reporting requirements, garden leave rules and much else should be reviewed and new rules strictly enforced. There is a clear line, but it is a difficult one to draw and to police.

And the Federal Reserve?

The biggest question of all is whether the Fed under chair Janet Yellen will start to act more as a central bank for the world. Will it take into account the international spillovers of its policies? Will it inform other central banks of its thinking?

The answer is no, no and no. But that takes us back to the fault-lines in the system and the limits of contemporary central banking.