Central Bank Independence Is No Cover For Central Bank Incompetence

The wave of criticism of central bankers hasn’t let up in October with a Barron’s article arguing that central bankers are the truly scary clowns. Politicians have joined in the criticism with Theresa May and Donald Trump calling out the negative impacts of current monetary policy. What has changed is there is something of a fight back based on the concept of central bank independence. I’m a strong supporter of central bank independence, but a strong critic of central bank incompetence. Central bankers that ignore the obvious evidence of asset price bubbles and yield chasing, created by their ultra-low interest rates and money printing, should be sacked just like any other underperforming employee. The questions are who will replace them and what monetary policy should be targeting.

The primary central bank target is typically an inflation level of around 2%. There can also be some vague targets for stable economies (not too hot or cold), economic growth and/or unemployment rates. These add-on targets are unrealistic as central banks are limited to interest rate settings and control of the money supply. These two levers can help to control inflation, but by focussing on trying to boost economic growth central bankers have created instability in financial markets and economies. Truly independent central bankers would have stopped lowering interest rates long ago. They would have told politicians to implement structural and productivity reforms that will help lift economic growth rather than running Frankenstein experiments with interest rates and money printing.

What then should central banks target? The primary focus of central banks should be to ensure that inflation does not exceed a specific bound. The economic and social destruction caused by inflation has been shown in Weimar Germany, Zimbabwe and Venezuela. However, the idea that inflation must be positive should be dispensed as there is no evidence that small levels of disinflation are a problem at all. If your goods need to be replaced, will you go without for long periods simply because they might be 1% cheaper in a year? Even when disinflation is occurring, it will typically be as a result of excess capacity in an economy. Most often this overinvestment originates during boom periods when interest rates are too low.