Global Economy: Impact of Political Power on the Central Banks
While Paul Tucker, former deputy governor for the Bank of England who had a front seat as the financial crisis unfolded, said central banks have emerged as a “third great pillar of unelected power alongside the military and the judiciary”, and Yuhang Liu argues that no central bank can work in a political vacuum, I feel the more independent a central bank is, the less the inflation rate would be. As the world is considered as a single market, central banks will dominate the global economy; where the political power on the central banks avoids economic crises. A central bank is a monetary institution that is responsible for managing the financial system and policy either of a nation or a group of nations. The central bank works on the regulation of money supply and setting the interest rates which helps in participating in open market operations to control the cost of lending and borrowing throughout an economy. In 2016, more than half of the assets of the central bank were controlled by the centres in China, the United States, Japan, and the eurozone; where eurozone is the group of nineteen countries who use the euro common currency. The duty of the central banks is to implement specific goals that includes stability of currency, low inflation, and full employment which tries to show a steady GDP growth. Central banks play an important role in the global economy because a country’s foreign exchange is controlled by the central bank and also it sets the monetary policies that influence the national money supply affecting the volume of international trade. When the Central banks are compared with the European Central Banks, the ECB creates a eurozone-wide banking union that grants the bank new powers of supervision and this supervision would be over the Europe’s largest financial institutions. Coming to the impact of the political power on the central banks, I can say that there will be a political relationship between financial sector and the central banks. This essay will discuss this particular political relationship discussed above specifically in the reference of the European Banks. Also, we will discuss the scope and limitations of this relationship. In the current situation of COVID-19 pandemic, it takes almost years to cover the economic crisis. As per the reports made in (United Nations, 2021), in 2020, the world output shrank by 4.3% over the financial crisis of 2009. However, the recovery was expected of 4.7% in 2021. We will discuss both the sides of central banks being independent and the bank being influenced by politicians. Thus in my view, the argument that central banks being influenced by politicians is somehow not that beneficial to the country’s economy and in this essay I will provide facts that central banks have to be independent.
Main Body
I will begin the analysis by focusing on the economic crisis management. In the recent times, the central banks play an important role in the international economic crisis and also in the crisis management. Hence, new responsibilities are being assigned to the central banks mostly in the euro area. According to Mr. Erkki Liikanen, the financial crisis changed the operations of central banks and will continue to do so that led to the rethinking of central banking functioning and instrumenting. This was the statement in 2013. Moreover, there was a prediction made in 2016 that central banking has already entered into a new era that rises public expectations and by 2020, many aspects of the central banking will be transformed. Despite many challenges being faced by these banks, there was support from a new generation and the support by the political power that averts future economic crises that maintains monetary and financial stability. However, due to the pandemic situation being faced in the current times, it is critical to maintain the standards.
Central banks and the Global Economy
As per Yuhang Liu, the central banks are the anti-competitive and non-market-based institutions. Moreover, these central banks control money supply and its credit condition to achieve economic development. Central banks have legal monopoly status that have right to issue notes and cash; in other words, they can issue currency. Monetary stability functions increase the interest rates of bonds and loans to avoid inflation. Furthermore, the financial stability function and regulatory functions maintain capital, deposits, and reserves. Finally, the lending functions act as an emergency lender for the other banks and financial institutions. While, Paul Tucker says that central bankers act as the unelected officials; however, they have an influence on economies and the wellbeing of citizens. Also, the central banks have more power and influence during the recession as they bring the global financial system back from the edge.
Politics of Globalisation and World Economy
Paul also says that every country that has an independent central bank, politicians make comments about what the central bank should do. The central banks have to be independent of politics. However, the banks cannot take the power away. But so long as the power given by the sovereign parliament exists, the day-to-day note of commentary from the president or the finance minister or whatever does not exist. Hence, that has to be signed off. This is the view from Paul how central bankers around the world feel about it.
We can observe an uneven development in the world economy that is growing quickly and changing status by most of the developing countries. There is a support by the government of international economic flows, International Monetary Fund, world bank, etc., that leads to the cooperation among the countries. Moreover, the world economy not only opens up the economics but also lifts up the trade barriers to ease international trade. Let us consider an example of the emerging economies that is a part of international market in India and China that increased from 1.5 million to 3 billion. Globalisation changed economic interface that improved the standards of living in an economy. It is clearly observed that there is an international competition and transfer of knowledge. The political pressure boosts the output for a smaller period say only during the times of elections. However, there are many risks and challenges of Globalisation that has to be overcome by the Central Banks. For instance, we can consider the present pandemic scenario.
The central banks’ assets and liabilities with the combination of the size of balance sheets have replaced the significance of policy rates. The price stability is achieved by controlling the money supply. Central Banks use open market conditions to provide liquidit for banks through collateral policies.
Central bank independence
The independent central bank is also called as Autonomy; however, an independent central bank is not possible in reality. As per one of the articles, central banks have been embedded in economic and political coalitions and conflicts, central banks need to maintain balance between cognitive completeness and normative expectations. However, the term independence brings out the privatisation of central banks that pressurises the financial market. According to the European financial and sovereign debt crisis, the position of the European Central Bank has been revived in terms of its independence and democratic legitimacy. However, there are many researchers going on that raise not only the legitimacy actions of ECB but also the functions and position with the basic European Union Treaty. However, the ECB is affected in two different ways such as the baptism of fire and a test of its resolve to do whatever is necessary to follow its mandate. Peter prate, member of the European’s Central Bank executive board has stated that “Through acting, we also clearly demonstrated our independence and that we retain full control over our actions. Hence, ECB confronted addressing acute threats to the stability of the single currency. The main challenge was with the monetary policies which were following unconventional measures and supporting other European Union institutions in assisting the financial programmes. These challenges are to be overcome to maintain and secure financial stability.
During the crisis, the central banks will be questioned not only by civil society actors and academics but also by politicians. For instance, we can consider Germany’s conservative central bank was traditionally supported by political parties to find the provisional climax. However, this practice was not followed in the euro-area national central banks but the Governors participate in the ECB’s Governing Council with voting behaviour that have strict secrecy rules of monetary policy.
Central bank tools
There are many tools used by the central banks in the crisis to maintain the financial stability. Firstly, Bagehot (1873) has reported that offering a liquidity support against good collateral and penalty rate which is the part of a central bank’s traditional role as a lender of last resort. Secondly, monetary policy rate has to be reduced in response to the decrease in the demand; consequently, it becomes stable to its equilibrium value. Moreover, one more complementary tool that helps in this issue is that being committed to keep the policy rate at a low level for a certain period of time which reduces uncertainty and interest rates. Finally, central banks can use flexibility that acts as an additional tool. The meaning of this tool is to swap with the foreign central banks to provide liquidity.
ECB and the Euro system
The European Central Bank is based in Frankfurt and the central banks of the countries that use the euro. All together they form the Euro system. The main task of the Euro system is to define and implement monetary policy for the Euro area. This means maintaining price stability. In other words, keeping inflation rates at levels below but close to 2 percent over the medium term. High inflation would mean the prices rise rapidly so over time people would not get the same amount of goods and services for the same amount of money. So, the Euro system works hard to make sure prices remain stable. It has a number of standard monetary policy tools that it can use. The most important of these are the decisions it takes on key interest rates which influence the economy and price levels in the euro area. During the crisis, the Euro system has also temporarily used additional measures to help the functioning of the euro area. Important decisions in the Euro system are taken by the Governing Council of the European Central Bank. This body is made up of all the governors of the national central banks of the euro area countries and the members of the European Central Bank’s Executive Board. But the council members do not represent their own country. They vote in a fully independent capacity, in the interests of the euro area as a whole, and decisions are taken collegially with each member having one vote, so it is not just the president of the European Central Bank taking decisions alone. The Euro system also has a number of other tasks, such as ensuring the smooth operation of payment systems, making it faster, safer, and easier to make cashless euro payments throughout Europe. Holding and managing official reserves in foreign currencies and other assets and collecting and compiling a wide range of statistics. And the European Central Bank is also responsible for authorising the issuance of euro banknotes, some of which will end up in the people’s pocket.
Discussion
As per the analysis, there are two ways a central bank can be impacted with. One of them is an independent survival and on the contrast, it has to be politically dependent. Let us consider an example of the developed countries, here, the political power on its economy is invisible; however, in the under developing countries, the influence of government on the Central Banks is observed. Let us go to hundred years back to understand the story behind independence of the central banks. After the first World War, Germany was in a lot of debt and its costs were increasing. Soldiers need pensions and war widows needed compensation. France, Great Britain were demanding massive reparations and other countries did not want to lend Germany any money. So, Germany’s Central Bank printed more and more money and lended it to the government hoping to make the difference. However, they ended with hyperinflation. All that cash caused prices to skyrocket. At the height of the crisis, hyperinflation reached rates of more than 30,000% per month, meaning prices were doubling every few days. Hence, it was the first central bank to be given full independence and it quickly gained the reputation of being the world’s most independent and conservative Central Bank. At the same time, the Bank of England and most of its European counterparts were still controlled by the governments. Throughout the 1960s, most policy makers believed unemployment would be permanently lowered by accepting higher inflation. This was also called as Phillips curve. Here, as the Central Banks increases money supply, the inflation increases; that implies jobs are also increasing which is loved by politicians.
If a bank is independent, there is a freedom to conduct monetory policy as central bankers wish. Many Latin American and African countries had very high inflation rates when they were ruled by dictators. Central bank has control of its own budget such as Fed and ECB. For instance, in Fed, if the congress passes a law and the President signs on it, to abolish Fed; however, ECB was formed by an international treaty. Ultimately, central bank that are led by people are more independent than the ones are ruled by popularly elected officials. The Bank of Canada’s independence is limited by the Government that is responsible for the Canada’s monetary policy. Whereas, Paul Tucker says that different problems come up in different jurisdictions. For instance, in the United States, the Federal Reserve and its congressional overseers need to get to a place where the Fed isn’t suspected of lending to institutions that are fundamentally unreliable, which is bailing them out. Paul argues that it is the job of the politics, but not the job of the technocrats. It is very important to note that the policies are been comfortable with the people.
Moreover, banks alone can restructure and minimise the impact of crisis. For instance, during 2008 crisis, ECB took significant steps in mitigating the crisis. During this period, the European Central Bank opted non-standard refinancing operations that decreased money flow in the market. Later, the downfall of Lehman brothers found the uncertainty in the financial market. The interbank money came to a standstill and central bank used their policy rates to mitigate the crisis. This was done by cutting the policy rate by 1 percent by the end of the year 2008; however, Fed has cut its interest rate to 0.25%. In this way the central banks worked together to eradicate the crisis.
On the other hand, according to a few news sources, not only Trump but also Turkish President, Recep Tayyip Erdogan is at the forefront of attacks against his country’s central bank. He remains vehemently against raising borrowing costs which is believed to be the reason the bank has not increased them. Even Italy, India, Argentina, and Turkey are just a few of the countries seeing leaders push back against central bank independence; also, some are succeeding. With the resignations and firing of the central bankers, there are many motivations questioned. This led to a number of voices declaring that the independence of these public institutions is under threat.
Conclusion
By observing the above discussion, it is clear that the dominant force of the Central Banks is based on either the political power or the potential of apex bank. Globalisation made the world economies interconnected due to the economic crisis of one country affecting by another. In such cases, central bank mitigates risks and take necessary measures to minimise the impact of crises. Hence, it is better to go with the later method of independent central bank. Though the central banks are independent, there should be a limit of generating currency. As we have seen in the Germany example during world war, that created many problems in issuing more currency. Consequently, the central banks being independent is beneficial following proper guidelines.
References
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https:www.cfr.orgbackgrounderrole-european-central-bank
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3. United Nations., World Economic Situation and Prospects: February 2021 Briefing, No. 146. Global Economic Recovery remains Precarious-the projected rebound of 4.7 percent will barely offset 2020 losses.
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DOI:10.32629memf.v1i3.177
10. Paul Tucker., 2018. Post-crisis, Do Central Banks Wield Too Much Power? https:knowledge.wharton.upenn.eduarticlepost-crisis-do-central-banks-wield-too-much-power
