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Faculty Viewpoints

Are We Asking Too Much of Central Banks?

Central bankers are among the most powerful actors in the economy—just think of how a Fed chair’s gnomic utterances can move markets. Should such an influential force be directly accountable to the electorate? Or does it need independence to stay above the political fray and follow disinterested policy objectives? Paul Tucker and Yale’s William B. English, both former central bankers, discuss what the limits on central bank power are—and what they should be.

  • William B. English
    Professor in the Practice of Finance
  • Paul Tucker
    Former Deputy Governor for Financial Stability, Bank of England; Research Fellow, Harvard Kennedy School

Central banks face a conundrum. They need independence to prioritize long-term macroeconomic goals over short-term political pressures. But, to make choices that may be unpopular, they need the deep political and public support that, typically, come from accountability.

The U.S. sought to build that balance of independence and accountability into the structure of the Federal Reserve. The Fed is funded, not by Congressional budget appropriations, but through its own banking activities, providing one key form of independence. On the other hand, its overall objective—maximum employment and stable prices—comes from Congress, and the Fed chair addresses Congress on monetary policy twice a year. Members of the board of governors are nominated by the president and approved by the Senate, but they serve 14-year terms, allowing for an extended time horizon.

But he technocratic choices of central bankers do have political impacts. And some politicians are frustrated to not have more say on the Fed’s workings. President Trump told Fox Business, “My biggest threat is the Fed… Because the Fed is raising rates too fast, and it’s too independent.”

Should politicians have a free hand to run the economy? Should unelected technocrats be making choices that fall into the political realm?

Paul Tucker, former deputy governor for the Bank of England, who was directly involved in that country’s response to the global financial crisis, talked with William B. English, a Yale SOM professor in the practice of finance and a former member of the board of governors of the Federal Reserve System. They examined the dangers of asking too much of central bankers and some of the proposed solutions for distinguishing central banks and politics that Tucker developed in his book Unelected Power: The Quest for Legitimacy in Central Banking and the Regulatory State.

William English: There’s a lot of research showing independent central banks perform better on various metrics, but you have concerns about independence. What’s the nature of those concerns?

Paul Tucker: I am a big believer in monetary policy independence. I worry that too much is now expected of central banks. We hope they’ll solve all of the macroeconomic and financial problems that we have. I worry that some central banks have powers that make it possible for them to enter territory which really belongs to the politicians. The slogan is, “Central banks are the only game in town,” and I don’t think that’s sustainable.

English: Did these concerns arise during the financial crisis or earlier?

Tucker: They came to a head during the crisis, but I’d been thinking about them earlier. The Bank of England regained independence later than any other major central bank. There was a big debate in the UK from the late 1980s through to the late 1990s about that, and we thought very carefully about what powers we should have and what powers we shouldn’t have.

Unlike the U.S. Federal Reserve, the Bank of England doesn’t choose the inflation target; that’s chosen by the elected government. There’s a more careful distinction than perhaps here about what belongs to politics, and what belongs to technocracy.

Then we get to the crisis and suddenly central banks everywhere are being expected to do more, and more, and more—quantitative easing, credit easing, market maker of last resort, and please try to improve productivity growth, which is now a debate in the United Kingdom.

English: Income distribution.

Tucker: Income distribution. And in continental Europe, please could the European Central Bank rescue the Euro area and ensure that the European project continues? At that point, my goodness, that’s the sovereign. Is Mario Draghi the most powerful person in Europe, and should we feel comfortable if he is?

English: He’s a nice guy, but doesn’t that raise real questions about democracy?

“A lot of people have been complaining about what the president has been doing, but if I were the the head of any central bank, I would rather be attacked by my head of government in public than pressured behind the scenes.”

Tucker: It’s exactly that, and if it stays like that I would expect, over time, to see people who aren’t as nice, and aren’t as smart, to want to do that job. If it’s as powerful as that, it will start to attract people with political ambitions masquerading as technocrats. I don’t think Mario Draghi is that, but he stands so high in the order of European power that people are bound to be thinking, “I’d like that job one day.”

English: Back in 1997, when the Bank of England got its independence, there was actually a big debate about that; the Conservative Party was not in favor of it, at least initially. They came around after a while. What was the nature of that debate?

Tucker: You remember exactly rightly. It was on constitutionalist grounds. The then Conservative Party opposition finance minister said in effect, “We have a tradition in this country that people holding great power are accountable to the House of Commons. The governor of the Bank of England cannot be accountable to the House of Commons in that direct way.” So they voted against the bill. During that period Eddie George, who was governor at the time and a very fine central banker, said to me on more than one occasion, he used to wag his finger, “Don’t think this independence is secure until it has bipartisan support.” I think he was exactly right.

In fact, Labour stayed in power for so long, until 2010, that well before then the Conservative Party had come around to the idea that Bank of England independence was a good thing. Then, in 2012, they gave the Bank of England more powers in regulation. I was involved in the earlier episode, but I was intimately involved in the design of those later powers.

English: In the United States, right now, the president is expressing his views about monetary policy to the Fed and to the public. Is that to-and-from from the president to the Fed a way to ensure democratic legitimacy?

Tucker: I would rather it were going on in scheduled, structured, congressional oversight than in the way it is. A lot of people have been complaining about what the president has been doing, but if I were the the head of any central bank, I would rather be attacked by my head of government in public than pressured behind the scenes.

In his new book, Paul Volcker tells a story that when he was the chair of the Fed he was summoned to see President Reagan and his chief of staff, Jim Baker. They didn’t meet him in the Oval Office; Volcker speculates it was because there were no tapes in the room where they met. The president didn’t speak, but Jim Baker said something like, “The president is ordering you not to raise interest rates.”

An earlier episode in this country: the Nixon administration spread dreadful rumors about Chairman Arthur Burns, undermining him in public opinion. Now, I think, Burns went way over the line in accommodating Nixon’s wishes by helping to boost the economy before the 1972 election. I’m very critical of Burns in my book. I think he should’ve gone public. But I would rather have the president attack or pressure the Fed in public than use insidious private pressure.

There was an occasion, when I was at the Bank of England, I arrived for a monetary policy committee meeting and Ed Balls—a powerful politician in the UK, who I’ve now got to know in Harvard—had been on the radio arguing that the Bank of England should do this or that. Some of the members were a bit nervous, and asked me, “What do you think about this?” I said, “I try not to listen to the radio on the mornings of MPC meetings. Just shrug it off.”

My view is that if Parliament, or Congress over here, gives you these powers, it’s your duty to exercise them in the best way you can. If the politicians object, well, then they can get the law changed. But going back to your question, remember this: this president’s appointments and nominations to the Federal Reserve so far are good.

English: I agree. It’s been an excellent outcome for the Fed that maybe wasn’t obvious ex ante. In your book you suggest a range of possible reforms to balance independence of agencies where you argue there is an economic and policy rationale for that independence, but at the same time there is also a democratic imperative. Can you describe a couple of reforms that you’d be interested in?

Tucker: One I would like to see, in this country and in other countries, would be an evolution toward a more precise objective for the banking regulatory and supervisory function. Some of your old colleagues are fond of saying that the Federal Reserve isn’t as independent in banking issues as it is in monetary policy. I think that’s an exaggeration. They can’t get fired, they have control over their instruments, and they have budgetary control. Well, that’s more independent than the Securities and Exchange Commission.

I know that they have to agree to things with other agencies, and so it is a bit different, but a bit. The really big difference is that the Federal Reserve has a fairly precise range of targets for monetary policy, and so the public can see whether the Fed is achieving what it said it would try to achieve whereas, on the supervisory and regulatory side, the Fed is charged with making banking safe and sound. How safe? How sound? How do we know that the Fed, or the Bank of England, or the ECB is doing what they’ve set out to do on that until there’s a crisis? Then, manifestly they failed. I think this is a big problem.

When I was, as you would call it, chief of staff to the Governor of the Bank of England in the late 1980s and early 1990s, the bank was responsible for banking supervision. When a bank failed there was, rightly, public uproar. The governor of the day asked his senior colleagues (I was the note taker in the corner): “We’re being rightly criticized for this, but no one knows about any of our achievements. We’ve got to find a way of doing banking supervision that is more”—in modern words—“transparent to the public,” and I think that is exactly right.

Actually, I see signs that the new leadership of the Federal Reserve, Vice Chair Randal Quarles and Chairman Powell, are quite keen on making that side of the Fed more transparent. I don’t know exactly what they should do, but I think moves and experiments in that direction would be a very good thing.

Since you asked for a couple examples, more briefly, I think that the Fed needs to make clear that they will not be lender of last resort to institutions that are fundamentally bust. They say that they don’t do that, but they need to make that credible.

“The Federal Reserve has been independent for a long time, but now it needs to be re-earning that independence, and underpinning it as much as it can.”

English: To do that you have to be confident in your resolution tools.

Tucker: Yes. I’ve said a few times in public that whenever central bankers talk about lender of last resort, and I think they should talk about it more often than they do, they should always start off by talking about resolution.

The institution in this country who should be most invested in the success of the Federal Depositing Insurance Corporation is the Federal Reserve Board and yet, it’s not a relationship that has always been excellent.

The central bank lender of last resort is in a very uncomfortable position if there isn’t a good bankruptcy and resolution regime because then they will they end up bailing people out that they shouldn’t, and we’ve all seen the politics of that—the perception of bailing out Wall Street, bailing out bankers rather than of providing liquidity to sound firms so as to help the American public. This is a massive perception gap.

When I’ve talked to some of your former colleagues about it, they’ve said, “Well, you can’t change those perceptions quickly.” My response is always the same: “But over 10 years you could.”

I think the difference between the Federal Reserve’s experience and Bank of England’s experience, during our professional lives, is that the Bank of England started off without independence and had to explain very carefully what it could do and what it couldn’t do. Whereas the Federal Reserve has been independent for a long time, but now it needs to be re-earning that independence, and underpinning it as much as it can.

English: Many of these changes would require adjustments to the Federal Reserve Act by Congress, but politics, at the moment, is incredibly fraught. Is the Congress in a position to implement reforms?

Tucker: Policymakers need to be ready with ideas for when the Congressional opening comes. Particularly after crises there’s often a moment of “something must be done”; that’s common in this country and others. Look at the speed of the Dodd-Frank legislation. The crisis was in early 2009; there was legislation by the end of 2010. There’s not much time for broad debate after a crisis. The key ideas have to be ready.

Before that, I think, one has to explain and try reasonably to shape public opinion including where there are weaknesses in the administration of the current setup, being completely open about that.

I think, for example, that central banks have been far too defensive about whether there have been distributional effects from quantitative easing. Rather than giving lots of papers saying, “The biggest effects on inequality are coming from elsewhere,” which I believe to be true as a matter of economics, I think it would be more prudent and central bankers would be listened to more, if they said, “Well, it’s not why we did it, but yes, it’s had the effect. It’s helped people keep jobs, particularly people in more insecure jobs. It has pushed up asset prices, and probably helped the rich. It probably has squeezed people who live off the income from savings”—that’s been particularly an issue in Germany.

Unless one makes the obvious points there are always members of the public who think, “These people just don’t get it,” and I think one can’t correct that in a day, or a week, or actually in a year, but I really believe that one can over 5 or 10 years.

Department: Faculty Viewpoints