Everyone should read this insider's epic critique of central banking in the post-GFC world

Photo: Vince Caligiuri/ Getty Images.

Have you ever participated in an exit interview from a job, or delivered a leaving speech, and regretted not telling your work colleges a few home truths in fear of “burning your bridges” in the future?

I’m sure there’s a few nodding heads right now.

No one can accuse Kristin Forbes of holding back, however. The outgoing external monetary policy committee (MPC) member at Bank of England (BoE) delivered an epic 27-page take-down of the problems in modern central banking in the post GFC-world in her final speech as a policymaker overnight.

Kristin Forbes. Photo: MIT

Entitled “Failure to launch”, Forbes, who will leave the BoE next week, discussed the inability of central banks in almost all developed countries to launch interest rates off the emergency levels adopted in response to the Global Financial Crisis.

It’s created quite a talking point across markets, particularly in light of the Bank of England’s latest monetary policy decision last week where Forbes and two of her colleagues voted to lift the BoE’s bank rate, against the majority.

To give you a taste of the speech, just take a look at the second paragraph:

Why are interest rates still near zero in so many countries — even though it has been almost nine years since the peak of the crisis? Why is so much monetary stimulus still believed to be needed — even as global economic growth has been above 3% for 7 years in a row and global inflation expected to pick up to about 3.5% by year end? Why are central banks so reticent to raise rates given their experience that interest rates at such low levels, especially for a prolonged period of time, can increase risks — such as fostering financial market bubbles and unsustainable borrowing, supporting an inefficient allocation of resources, and creating challenges for pension funds, savers and banks?

These are hard questions to central bankers around the world who, in comparison to her hawkish assessment, are far more dovish in nature.

In her opinion, she thinks there’s a reason policymakers have been “reluctant to launch” when it comes to interest rate increases: there’s a greater focus on the short-term, rather than the implications ultra-easy monetary policy has for the future.

Central banks have seen their remit expanded to include a broader set of considerations and have played a more public role, this could make them more hesitant to “take away the punch bowl” and make the difficult decisions that can be required to keep inflation stable.

Central bankers may place more weight on supporting the economy today and worry less about future risks related to low interest rates and high inflation if they are constantly on the firing line for the current state of the economy — including for issues other than inflation. As Thomas Hoenig, the former President of the Federal Reserve Bank of Kansas City, recently worried: “In a world of discretionary policy, when the moment comes to choose between long-run goals and short-term effects, policymakers experience enormous pressure to choose the more expedient short-run solution, deferring to another time concern with the long-run implications.”

Put slightly differently, do central bankers today put more weight on how tighter monetary policy could affect unemployment during their term and less on the costs of low interest rates in the future? Or given their more public roles, do central bankers today worry more about what could go wrong around the times that rates were tightened—even if any problems were not related to the increase in rates – knowing that they will be blamed nonetheless? As central bankers consider a broader range of economic and political concerns, could this shift away from the basic focus of monetary policy – inflation – mean it gets less weight in their decisions?

Along with a focus on the short-term, seemingly focused on protecting their legacy during their time as a policy setter without considerations for the future, Forbes says that there is another factor that may play a part in delaying policy normalisation.

Policymakers are no longer focused solely on monetary policy, but other areas of financial oversight too.

There is also the fundamental issue of time constraints. In the past, monetary policy was the key focus of most members of MPCs. Now, some members of the Bank of England’s MPC spend a substantial amount of time on other Committees and focusing on other mandates. For example, the Governor and Deputy Governors at the Bank of England now also sit on the Financial Policy Committee and Prudential Regulatory Committee. As an external member of the MPC, I only have the responsibility to one committee — and there are some weeks that it is hard to keep up with just that workload. Even for people who work extremely long hours, there are only so many hours in a day.

So time to focus on the job at hand, setting interest rates appropriately for economic conditions, may be also a factor hindering policy normalisation, in her opinion.

In concluding her speech, Forbes delivered a not-so-subtle dig at her compatriots on the BoE’s MPC, saying that it has been much quicker to adjust monetary policy in response to downside risks than upside in the post-crisis world.

“We adopted a large stimulus package in August due to concerns that the economy might weaken substantially — not waiting for hard data,” she said. “Then the economy outperformed for much of a year, yet today a majority of the Committee still does not support a recalibration of this stimulus.”

In her opinion, the time to begin withdrawing this stimulus is now.

“The ‘lift-off’ of UK interest rates should not be delayed any longer,” she said.

“Many of the factors that have justified keeping interest rates at emergency levels over the past few years have become less potent, and sterling’s depreciation has fundamentally shifted underlying inflation dynamics in a way that makes it more pressing to begin this voyage soon.”

She also signed off with a message to not only the BoE but also other central banks: they shouldn’t be reluctant to change interest rates, both up and down, should it be required.

“We should be less hesitant to adjust interest rates — in either direction — as the situation changes,” she said.

“Engineers are quick to adjust a launch date if there is a technical concern or if the weather shifts. We should do the same.”

The full speech from Forbes can be accessed here. It’s well worth the read.

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