Overburdened central banks

Over decades, if not centuries, the reputation of central banks has gone through ups and downs. The Great Moderation marked a period in which inflation came down from rather high levels. Growth and employment were at least satisfying and output variability declined substantially. Was this “goldilocks economy” the result of mere luck due to a decline in exogenous shocks (Stock and Watson 2003); or did it stem from improved macro policies, especially monetary policy (Romer and Romer 2002)? The jury is still out on this question. But this period nevertheless significantly enhanced the reputation of central banks and central bankers. It was almost inevitable that expectations regarding the future actions of central banks and their ability to control the economy reached an unprecedented peak as a result; a peak that was to prove unsustainable. The prestige enjoyed by central banks was further enhanced in the context of the financial crisis when the latter saved the world from a rerun of the Great Depression of the 1930s. The latest Annual Report of the BIS (2016) presents a concise assessment: “And yet the extraordinary burden placed on central banking since the crisis is generating growing strains. During the Great Moderation, markets and the public at large came to see central banks as all-powerful. Post-crisis, they have come to expect the central bank to manage the economy, restore full employment, ensure strong growth, preserve price stability and foolproof the financial system. But in fact, this is a tall order on which the central bank alone cannot deliver. The extraordinary measures taken to stimulate the global economy have sometimes tested the boundaries of the institution. As a consequence, risks to its reputation, perceived legitimacy and independence have been rising” (p. 22). Disappointments with “politics” in general, combined with a loss of trust in politicians, helped to concentrate expectations on the competence of central banks. The crisis of the European Monetary Union (EMU) is a special case, which is characterized by the ECB being seen as the “only game in town”. This phenomenon will be analyzed later.