The sham of central bank independence

Let it be noted that the Japanese government 10-year bond yield hit 0.33 per cent overnight. That tells you that all the scaremongering that has been going on over the last twenty years about hyperinflation, the Japanese government running out of money, the bond markets dumping the yen, and the rest of it were self-serving lies designed to advance a particular ideological position at the expense of the broader social well-being. A year ago, the yields were 0.88 per cent – so they are going in the opposite direction to that predicted by many mainstream economists, blinded by their irrelevant textbook theories about how markets work. In that neo-liberal textbook fairyland, the yields should be sky high now, inflation accelerating out of control and the government forced to admit it had run out of money. Get over it, it won’t happen because the real world doesn’t operate like that. Students of macroeconomics are continually being taught a myth, which is detrimental to their education and life experiences. Many turn into the future doomsayers and sociopaths in organisations such as the IMF, the European Commission and other like policy making institutions. They always rave on about the need for more central bank independence to insulate monetary policy from political decision-making as if that will foster the well-being of the population. The idea of central bank independence is a sham and in the last week there has been stark evidence to support that view.

Bloomberg carried an Editorial yesterday (December 22, 2014) – Central Bankers Weren’t Meant to be Heroes – which carried a nuance to the normal arguments about monetary policy.

Essentially, the article rehearses the claims that the difference between the current economic fortunes of Europe and the US come down to the capacity of the central banks in each jurisdiction to introduce unorthodox expansionary policy measures.

I touched on this topic last week in this blog – Central banks can sometimes generate higher inflation.

They certainly do not understate their claim:

When the history is written, though, one theme will be paramount: It was the world’s central bankers, not its elected politicians, who had to deal with the crisis — a task for which they weren’t adequately equipped (and still aren’t). Some rose to the challenge; others didn’t.

They clearly implicate the lax central bank oversight before the crisis as a problem as governments around the world deregulated financial markets and introduced labour market policies that constrained the capacity of workers to enjoy real wages growth in line with productivity growth and thus facilitated a massive redistribution of real income to profits.

That redistribution provided the casino chips for the now freed and laxly regulated financial markets to go crazy. And they did.

But once the crisis ensued, the Bloomberg editors claim that:

Later, when it came to damage control and then to shaping the recovery, central banks were no longer junior partners. Fiscal stimulus was too timid or too brief or both, and as the politicians flailed, central banks were thrust all alone to the front.

Their idea is that elected governments, through their inaction, forced the central banks to stretch “the limits of their mandate”.

With a “puny” fiscal response and interest rates down around zero, the central banks “had to resort to unconventional measures, especially quantitative easing”.

According to their narrative, this also stretched the concept of central bank independence because “the line between monetary policy and fiscal policy is fuzzy to begin with, and large-scale QE blurs it further”. Why?

When a central bank finances the government’s deficit, that’s as much a fiscal operation as a monetary one. QE, as implemented, has taken the form of secondary-market debt purchases — government financing, you could say, one step removed.

As we have seen in the past, Modern Monetary Theory (MMT) also considers the artificial distinction between monetary and fiscal policy as presented in the textbooks to be problematic and largely obscures the essential transactions that go on and their impact.

Please read my blog – The consolidated government – treasury and central bank – for more discussion on this point.

A more interesting way of thinking about fiscal and monetary operations is presented by MMT by analysing what happens to the net worth of the non-government sector as a result of a government policy change (central bank or treasury).

So a fiscal operation is considered to be one which changes the net financial assets (net worth) held by the non-government sector. A monetary operation does not and only alters the portfolio composition of net worth held by the non-government sector.

Please read the following introductory suite of blogs – Deficit spending 101 – Part 1Deficit spending 101 – Part 2Deficit spending 101 – Part 3 – for basic Modern Monetary Theory (MMT) concepts.

It is thus problematic to consider QE to be a fiscal operation, although if it is used to support expansionary fiscal policy – as in say – OMF – paranoia for many but a solution for all – then one could say it facilitates the increase in net worth of the non-government sector but only because it might help a cash-constrained central government (a Eurozone member) spend more.

See – Quantitative easing 101 – for an explanation of the impacts of QE.

According to Bloomberg, QE can be anything from buying government bonds on the secondary markets to sending all the population a cheque (so-called “helicopter” option). That degrades the distinction that MMT makes.

The latter clearly is a fiscal act, while the former is not.

Please read my blog – Keep the helicopters on their pads and just spend – for more discussion on this point.

But the Bloomberg article, oblivious to these technical points, wants to say that QE breaches “the contract under which independent central banks operate” which according to the authors:

… makes it easier to understand the ECB’s position. The euro area needs QE urgently — but, unlike other central banks, Europe’s is forbidden by law to finance governments.

While they note, sensibly, that “Europe’s political leaders, if they had the wit and the nerve, would change this law”, one could easily dispute the claim that the Eurozone desperately needs QE.

What the Eurozone desperately needs is a massive fiscal stimulus preferably in the form of a large-scale public sector employment creation program coupled with an infrastructure development strategy.

There is a drastic lack of spending in the Eurozone. The lax investment spending in the US and the UK is testament to the fact that lowering longer-run investment borrowing rates, which is effectively what QE achieved did not stimulate much spending.

The point overlooked by the article is that though the fiscal response in the US and UK was not as large as one might have imagined the fact remains that both nations retained significantly larger deficits for an extended period that overlapped the growth resumption.

In the case of the US, while the polity wanted to cut net public spending they were unable to as a result of a fractious political system. Had the Tea Party Republicans got their way in the last Presidential election, then things would certainly have been worse.

So the point of departure with this article is that it pretends the fiscal effect was minimal and the recoveries were down to the QE, which is both illogical and counter-factual.

The other point that the Bloomberg editors make is that by compromising the independence of the central banks the advanced nations have endangered our financial stability, a proposition that is almost to ludicrous to contemplate.

The editors think that central banks would be paralysed if they were brought “under closer political control, so that they could more legitimately engage in quasi-fiscal operations”. No reason or discussion is provided. Just the neo-liberal mantra – it doesn’t need explaining does it – we just believe. Like a religion – don’t dig too deep or one will soon reach uncomfortable impasses – resolved by the appeal to “faith”.

A reasonable application of MMT would see central banks collapsed into a transparent Treasury operation. Then all economic policy is accountable through the democratic process and this period of central bankers deliberately causing unemployment but not being accountable for their actions would be gone.

Of course, central bank independence is only a convenient ruse. The ECB certainly doesn’t respect the concept.

I remind everyone that the – Tasks – (the Charter) of the ECB within the Euro system is well-defined by the Treaty of the Functioning of the European Union.

The Statute of the European System of Central Banks and of the European Central Bank is one of the protocols attached to the Treaty. There are nuances because some of the central banks did not join the euro but they are not at point here.

It is very clear specified in Article 127(1) of the Treaty that:

The primary objective of the European System of Central Banks … shall be to maintain price stability”.

Clear enough?

They will do this, according to Article 127(2) through:

– the definition and implementation of monetary policy for the euro area;

– the conduct of foreign exchange operations;

– the holding and management of the official foreign reserves of the euro area countries (portfolio management);

– the promotion of the smooth operation of payment systems.

Additionally the ECB is responsible for “the prudential supervision of credit institutions established in participating Member States” and “has the exclusive right to authorise the issuance of banknotes within the euro area”.

That is about it.

It is not responsible for enforcing European Commission dictates with respect to the Member States about fiscal policy, labour market policy, product market policy or anything else like that.

On August 5, 2011, the head of the ECB wrote to the Spanish Prime Minister José Luis Rodriguez Zapatero. The letter is available from the – ECB – after it was reclassified for public release on December 19, 2014.

It demonstrates how involved the ECB was in pushing the Troika line, which is not the impression it gave back at the time and also demonstrates that the neo-liberal concept of independent central banks is another one of those myths that allow policy makers to deflect responsibility for poor decisions that damage the prospects of people.

Please read my 2009 blog – Central bank independence – another faux agenda – for more discussion on this point.

More recently, I noted how the Australian central bank governor was on, the one hand, a defender of the concept of independence, but on the other hand, quite prepared to lecture the elected government on what fiscal policy settings should be – Friday lay day – central bank governor disgraces himself

Central bank independence is part of the grand myth that governments cannot be trusted not to create accelerating inflation as a result of political machinations overriding economic responsibility.

The Bundesbank is cited as the exemplar for producing price stability even though at various times its adherence to this principle has generated sizeable recessions in Germany and elsewhere. During the European Monetary System days (the precursor to the common currency), the German central bank clearly caused its European neighbours to deliberately create mass unemployment because it refused to honour agreements under the EMS to participate in symmetrical defence of the exchange rate agreements.

The mainstream Monetarist literature, which emerged in the 1970s, promoted the idea of central bank independence because it was a way to take policy discretion from the democratically elected governments and thus reduce the scope of government economic activity. It was part of the plan to privatise, deregulate and shift the balance of power to the top-end-of-town after years of social democratic decision making in the Post World War II period.

The concept of ‘dynamic inconsistency’ entered the nomenclature with the Monetarists and highlighted the virtue of so-called monetary rules – where the central bank would announce, say, an inflation target and then adjust policy (interest rates) rather mechanically to keep inflation within the announced band. But monetary rules didn’t necessarily mean that central banks should be independent of the government.

If you want to learn more consult my 2009 blog. I don’t think it is useful to just rewrite that.

The ECB letter from the bureaucrat Trichet to the democratically elected Prime Minister of Spain is astounding if not just for its breathtaking arrogance and presumption.

The letter reports that the Governing Council of the ECB met the day before about Spanish bond markets. At the time, the 10-year bond yields had risen throughout 2011 from 4.09 per cent in August 2010 to 5.25 per cent in August 2011. This was at a time that the German bund yield was falling, which meant the spread was widening.

The ECB letter reminded (hectored, in fact) the PM that on July 21, 2011, all the Heads of State had agreed that:

… all euro countries solemnly reaffirm their inflexible determination to honour fully their own individual sovereign signature and all their commitments to sustainable fiscal conditions and structural reforms.

Note the terminology with respect to government policy in an unfolding crisis – “inflexible determination”. The so-called “sustainable fiscal conditions” were the Stability and Growth Pact rules and the structural reforms were the cuts in public spending, public employment, privatisations, pension cuts and the rest of it.

In other words, Spain was being asked to stay firm on continuing to damage the prospects of its own population – inflexibly.

The situation in Spain deteriorated after this as we all know.

The ECB letter clearly determinied that Spain was not honouring its obligations. Trichet demanded (as “essential”):

1. “further significant measures” to cut workers employment protections, wages, supplements etc.

2. They explicitly wanted the Spanish government to abandon “inflation-adjustment clauses” in wage contracts to ensure that real wages fell. Defending real wages were considered by the ECB to not be “appropriate feature for labour markets inside” the monetary union.

The government was “encouraged … to take bold and exceptional steps” in this regard.

3. The government was also urged to “take exceptional action” to undermine private sector employment conditions and to review “labour market regulations” immediately, with the view to creating “very low severance payments” and “eliminating all restrictions for the roll-over of temporary contracts”.

It also demanded that the Spanish government to announce further fiscal cuts.

And if that wasn’t enough, the ECB demanded that the Spanish government deregulate the rental housing market, deregulate professional services among other things.

Conclusion

At least the Bloomberg article noted that fiscal policy inaction by governments had forced more responsibility on the central banks than they should reasonably have.

The alternative story – which is core mainstream economics – is that there should be no discretionary fiscal policy and that all counter-stabilisation should be accomplished through monetary policy.

The depth of the crisis were are still labouring in has demonstrated the fact that the mainstream approach fails and the world would have been locked in a massive Depression – Greek style – if the treasuries had not have invoked a major fiscal response.

Subversion of the peoples’ will

The NSW government’s decision to tear up our local rail line in Newcastle and truncate the line several kilometers out of the heart of the city to allow private property developers to exploit the valuable harbourside land took a new twist today.

The press is reporting (December 23, 2014) – Newcastle rail infrastructure shifted to development corporation, court hears – that to subvert a court challenge initiated by local activists Save our Rail on the legality to terminate the line on Boxing day that the NSW government has transferred all the infrastructure from Rail Corp (the operator) to the Hunter Development Corporation, a nasty pro-development NSW government body.

The court case heard that the cutting of the rail line is illegal under Section 99A of the Transport Administration Act, which prevents a rail owner from disposing of a rail line except by act of parliament. There has been no Act passed to allow this to go ahead.

The NSW government to overcome the illegality of their move has now disposed of the rail assets to the HDC under a compulsory acquisition, which technically does not involve a sale or disposition. In the latter cases, the act would be breached.

The Government is claiming that because the HDC, the new owner of the assets, is not a rail operator it can close the line without an Act of Parliament being required.

In other words, while the line will be terminated on Boxing Day, the Government is not “closing” it because it has just transferred the assets to a non-rail operator. Joke, eh!

So this sleazy government and its instruments are shifting public infrastructure around within its own departments to bulldoze a decision that the local people have vehemently opposed. Why? So their property development mates can get their hands on the land and profit.

This article (December 22, 2014) – Rail decision made without community – tells some of the story.

I usually only worry about macro issues – but this is local corruption which makes one sick.

That is enough for today!

(c) Copyright 2014 William Mitchell. All Rights Reserved.

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    12 Responses to The sham of central bank independence

    1. Warren Ross says:

      I have always considered the rail trip to the centre of Newcastle an important part of any trip there. The hands of people like neoliberal Nick Greiner are all over this privatisation and land rip-off. The rail should be promoted but unfortunately it is not and the lack of an effective visitor information centre near the station is to Newcastle’s great loss. NSW Tourism compares very unfavourably with similar services in other states. I should know. I live in Katoomba.

    2. Thorvald says:

      Great post Bill; thanks
      Same issue I dealt with in history of the Fed-Treasury Accord, see my one-pager one this important event
      http://www.levyinstitute.org/pubs/op_37.pdf
      Happy holiday!

    3. postkey says:

      “The lax investment spending in the US and the UK is testament to the fact that lowering longer-run investment borrowing rates, which is effectively what QE achieved did not stimulate much spending.”
      In the UK.
      “The banking industry is the biggest zombie of all. It’s sapping the life blood out of savers as well as industry. The low rates offered by the Bank of England aren’t passed on to most punters.”

      http://www.moneyweek.com/news-and-charts/economics/uk/right-side-how-long-can-this-farce-continue-61414

      In the UK, the lower interest rates have contributed to consumption expenditure?
      “The Council of Mortgage Lenders estimates that borrowers have collectively saved around £100 billion over the past five years.
      A study by McKinsey estimated that savers lost a cumulative £66 billion in interest between 2007 and 2012.”
      https://www.lovemoney.com/news/27271/winners-losers-five-years-of-record-low-interest-rates

      In the US.
      “To me, that’s really the key piece, because the impact that QE had on real estate is arguably the most effective part of this whole policy.
      I share a lot of the cynicism about the effectiveness of QE and whether it just expanded the wedge between the haves and the have-nots. But it clearly helped generate this recovery in real estate prices, which did lift 5.5 million households out of negative equity. That had a legitimate cash-flow impact, as these people could either sell their homes and relocate to find a job or refinance their mortgage, because suddenly their homes weren’t underwater. So it had a legitimate, positive economic impact that you can quantify, to say nothing of the benefit to the financial sector.”
      http://online.barrons.com/news/articles/SB50001424053111903301904579561672621644240

    4. postkey says:

      This, from the Bloomberg ‘editorial!

      “Greater fiscal restraint when economies are doing well means that bolder fiscal stimulus will be possible when they aren’t. All this requires a much more forward-looking approach.”

    5. John Doyle says:

      Do you not agree, Bill that demographic realities should be intruding onto the discussion about the downturn in the western world’s economies? The world is getting older.The USA reached “peak spending” between 2003 and 2007. It cannot recover the spending that went on before 2007 by virtue of the decline evident since 2007 in the cohort of working age population. Ditto Japan after c.1990. and the rest of the West going through it now. As Harry Dent write ” when the dyers outweigh buyers, the market changes”. Is this what we are seeing today?

    6. The Dork of Cork says:

      Sure , independence is the wrong word.

      They simply own you via their top down credit policies.

      Goggle Richards Werner’s “Princes of the Yen”

      A 1h 30 m documentary based on his book of the same name.
      With a conclusion looking at the masters of the euroroboten..

      These are deeply political agents of destruction.
      The eurozone govs are in some senses quite refreshing as they are open about it.
      Who can not now claim that the credit hyperinflations of the eurozone periphery were political acts of malice designed to destroy social cohesion and thus transfer ever more power upwards .

    7. The Dork of Cork says:

      ‘What the Eurozone desperately needs is a massive fiscal stimulus preferably in the form of a large-scale public sector employment creation program coupled with an infrastructure development strategy’

      Nope.
      Europe has machines and infrastructure coming out of every road to nowhere.
      Europe needs local spending power.
      Any dork could tell you this.
      A critical mass of activity must first start in the villages and market towns.
      This requires bottom up interest free credit.

    8. postkey says:

      “The lax investment spending in the US and the UK is testament to the fact that lowering longer-run investment borrowing rates, which is effectively what QE achieved did not stimulate much spending.”

      Was the lower rate of interest passed on?

      “Now, what’s interesting is that following the 2008 crisis, even as Libor slumped from 5% to 0.5%… the banks barely changed what they charged customers!
      Today the average overdraft rate is still 10%. Funding costs are down to practically zero, meaning nearly double the profit per loan!
      The banking industry is the biggest zombie of all. It’s sapping the life blood out of savers as well as industry. The low rates offered by the Bank of England aren’t passed on to most punters.
      To claim that if base rates go up then ‘zombie’ firms will fail is to miss the point. Because the fact of the matter is that many never benefited from lower rates in the first place. Especially not those that were struggling.”
      http://www.moneyweek.com/news-and-charts/economics/uk/right-side-how-long-can-this-farce-continue-61414

      Maybe the lower rate stimulated consumption expenditure?

      In the UK.
      “The Council of Mortgage Lenders estimates that borrowers have collectively saved around £100 billion over the past five years.
      A study by McKinsey estimated that savers lost a cumulative £66 billion in interest between 2007 and 2012.”

      https://www.lovemoney.com/news/27271/winners-losers-five-years-of-record-low-interest-rates

      In the US.

      “To me, that’s really the key piece, because the impact that QE had on real estate is arguably the most effective part of this whole policy.
      I share a lot of the cynicism about the effectiveness of QE and whether it just expanded the wedge between the haves and the have-nots. But it clearly helped generate this recovery in real estate prices, which did lift 5.5 million households out of negative equity. That had a legitimate cash-flow impact, as these people could either sell their homes and relocate to find a job or refinance their mortgage, because suddenly their homes weren’t underwater. So it had a legitimate, positive economic impact that you can quantify, to say nothing of the benefit to the financial sector.”
      http://online.barrons.com/news/articles/SB50001424053111903301904579561672621644240

    9. postkey says:

      “The point overlooked by the article is that though the fiscal response in the US and UK was not as large as one might have imagined the fact remains that both nations retained significantly larger deficits for an extended period that overlapped the growth resumption.”

      “Even Britain has now abandoned austerity . . .
      And while Osborne will never publicly admit this, the big surprise of his budget is its implicit acceptance of this Keynesian view.
      Instead of trying to reduce borrowing any further or aiming for a balanced budget, as it originally promised, the British government has now accepted that deficits will keep rising in absolute terms and will still be worth 6% of GDP by the next election in 2015. That would leave Britain with by far the highest deficit ratio among the major economies after five years of unprecedented austerity. Meanwhile the U.S., with comparatively little fiscal effort, is projected to reduce its deficit to just 2.4% by 2015.
      We are still looking at borrowing of £108 billion this year – nearly £50 billion more than planned back in 2010.”
      http://blogs.reuters.com/anatole-kaletsky/2013/03/21/even-britain-has-now-abandoned-austerity/

    10. Icarus Green says:

      This is a fascinating article. I wrote a bit about this myself and while back on my blog but more in political terms. Central Bank independence, commissions, working groups, IMFs, European Courts of Justice and other seemingly neutral technocratic bureacracies are really ways to transfer power from elected people who theoretically represent average people and transfer power to shadowy country club assholes who have an interest in a certain form of wealth distribution and deflation.

      If you talked to someone 50 years ago and told them how much law, economic control and political power rests now with unelected, unaccountable bodies they would be shocked.

      Of course, our beloved aristocracy’s plan is for this exact scenario, ultimately culminating in the return of feudalism in some elaborate form.

    11. Anyone who pushes QE and infrastructure under the circumstances is imo highly suspect, no matter that most of the analysis is fair to middling.One never knows what agenda a person pushes but by the nostrums advanced.Generally, in the western socalled democracies the benign paternalistic form of governance has come and gone.It did not last but a few decades.all the analyses and nice plans on offer by lay experts will not do nowt, as the system has been hijacked by interests which have a different agenda.Obviously, if people wish for social democracy in western and or all of Europe to be maintained, something revolutionary has to happen.
      For the first time people would have to take control and make a go of it themselves, this in the face of the might of the globalising corporates.They should do this, we should do that,….It does not add up if people have not the wherewithal do implement measures.Since way back, people have been writing books about the system.Babylon’s Banksters is a good one, but there are many.The Rotten Heart of Europe is another.
      Except for people to wake up and get to understand how it works, there is no comfortable solution.

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