Central bankers rarely say anything that sticks in the memory. Mark Carney has been at the Bank of England for the past six years and is known as the rock star central banker, and not always in a good way. His answers to questions at press conferences are often like solos from the lead guitarist of a 1970s prog rock band: long and boring.
Indeed, only two central bankers have ever come up what might be called zingers. William McChesney Martin, who ran the US central bank for almost two decades from 1951 to 1970, said the Federal Reserve was in the position of a “chaperone who has ordered the punch bowl removed just when the party was really warming up”.
Fifty-seven years later Mario Draghi turned up at a conference in London at a time when intense pressure on Italian and Spanish bond yields had fuelled speculation that Europe’s single currency might collapse. The ECB president responded by saying that the bank was “ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” It was.
Donald Trump, it’s fair to say, doesn’t have much time for the Martin theory of central banking. The man he appointed to run the Fed, Jerome Powell, tried to remove the punch bowl by gradually raising interest rates and has received nothing but abuse from the White House for doing so.
The president wants the party to continue and is going to have his way. This week the Federal Reserve is expected to cut US interest rates by 0.25 percentage points, not because the economy is in recession – the annual growth rate is just over 2% and unemployment the lowest in 50 years – but as an insurance policy against a possible downturn. Trump will almost certainly castigate Powell for being too timid. With his 2020 reelection campaign already in full swing, the president is after a half-point off rates.
In retrospect, Trump blundered when he decided to replace the ultra-doveish Janet Yellen at the Fed for no other reason than she was a Democrat who had been appointed by Barack Obama. And given the choice, he would choose Draghi over Powell.
Why? Because during his time in Frankfurt Draghi has transformed the ECB so that it is no longer a clone of the German Bundesbank on which it was modelled. The ECB had been rigidly orthodox during the financial crisis and its immediate aftermath, being too slow to try the money creation process known as quantitative easing and too quick to raise interest rates.
Draghi has over time worn down opposition to a more activist approach, to the extent that during his last months at the ECB the bank will cut interest rates and resume QE. The old deflationary bias – the ECB has traditionally cared more if inflation is above 2% rather than below 2% – has gone too.
The current developments at the Fed and the ECB show how central banking has changed. Under the gold standard, monetary policy and interest rates were governed by whether gold was flowing in or out of a country. That was central banking 1.0.
Martin’s quote summed up central banking 2.0. The 1950s and 1960s were the high point of fiscal activism: managing the economy through the use of changes to tax and spending. Central bankers tended to be technocrats who operated out of the political spotlight. There is a story that president John F Kennedy could only remember the name of the man running the Fed because his name began with an M, the same as monetary policy.
By the time of “whatever it takes” central banks had become more powerful and more visible. The use of fiscal policy had fallen out of fashion and monetary policy – controlling the economy with the levers of interest rates and money supply – ruled supreme. When the financial crisis of 2007 turned into the banking crash of 2008 it was to independent central banks that governments looked to mitigate the impact. This was the high point of central banking 3.0.
But the decade since the financial crash has exposed the limitations of central banks, even when in hyper-active mode. Martin’s metaphor was entirely appropriate in 1955 because the postwar party in the US was in full swing, with full employment, strong growth and rising living standards for all. The party since 2008 has been small and exclusive, largely limited to the richest 1%.
What’s more, cuts to interest rates of the sort the Fed will deliver this week are much more about keeping spirits high in the financial markets than they are about the real economy. It was the collapse in share prices on Wall Street in the final three months of 2018 – rather than anything that was happening on Main Street – that changed Powell’s mind.
Andy Haldane, the chief economist at the Bank of England, gave a speech last week acknowledging the new reality. Central banks had done all they could to boost demand. Low interest rates and QE had helped mop up all the spare capacity – jobless people looking for work, companies with the potential to produce more goods and services – left by the worst recession since the 1930s. But now, Haldane said, it was the time of fiscal policy and structural reform to play a bigger role.
This sounds right. Eventually there will be another global recession and coping with it will require a different approach to that used in 2008-09. Monetary policy will become relatively less important and the line between it and fiscal policy will become blurred. A less technocratic and more political hybrid of the Martin era and the Draghi era approach, this will be central banking 4.0.