Central Bank summit: A chance for change or more of the same?

20th July 2012

The Bank of England govenor has sent a letter to his fellow central bankers ahead of the meeting saying that he wants to use it to discuss alternatives to Libor: "The Bank of England governor told fellow central bankers in a letter that it was "very clear that radical reforms of the Libor system are needed". The move comes after the Barclays Libor inter-bank rate-rigging scandal.

US Treasury Secretary Timothy Geithner said on Wednesday that reforming Libor "must be a multi-national effort."

But, while the Libor scandal is occupying the minds of central bankers at the moment, there are perhaps other more pressing topics that should be up for discussion.

For example, quantitative easing is becoming more controversial and less effective.


This piece on Zerohedge examines the evidence based on a report from Credit Suisse: "After all, few would argue that US interest rates are too high or that banks in the US need still more excess reserves. Two things stand out in their analysis of how QE is supposed to work (transmission mechanisms) and its results to date: QE1 was more effective than QE2, and it's easier to find QE's effect on Treasury yields than on real economic performance. Perhaps more concerning is that the potential negative effects of such unconventional monetary policy have received little attention."

If quantitative easing is becoming less effective, what other options are open to central bankers, if any? The European central bank has recently discussed whether there is room for interest rates to turn negative – i.e. creating incentives to borrow: 

Interest rates

"One obvious question is: why should there be a floor, a "lower bound", in the first place?

Some economists have called for monetary policy makers to push the interest rate at which banks can borrow from the central bank into negative territory. From a technical point of view, there is in fact nothing that prevents central banks from paying negative rates for the security they offer to depositors, at least temporarily. Given the costs associated with holding large amounts of banknotes, it is likely that significantly negative interest rates would be required to trigger a switch from money holding to investment in banknotes. So, there seems to be technical leeway."

The arguments against this would be that money market funds could be driven out of business and that zero or negative interest rates may produce adverse effects on the profitability of commercial banks and financial intermediaries more broadly.

Looking longer term, central bankers may have to decide on a strategy for exiting quantitative easing. We have written about this before on Mindful Money. No-one has yet exited a QE programme successfully and it remains a significant unknown.

There are those who believe that central bankers need to come to terms with a whole new reality.

Claire Jones writes in the Financial Times that central bankers need to reappraise their role and decide what they are going to control in future: "Since the onset of the crisis, the world's monetary authorities have been forced to ditch their inherent conservatism and embrace extreme measures on an unprecedented scale to stave off financial and economic collapse. Central banks have repeatedly been called on to step in, providing exceptional levels of support to the financial system, when governments have been unable or unwilling to act. Along the way, central bankers – traditionally seen as a reserved and cerebral bunch – have assumed the role of firefighting saviours. But their actions have in some respects compromised their credibility and revealed the limitations of their independence from politics."

Jones believes that central bankers will ultimately conclude that the use of their balance sheets as a policy tool is no longer likely to be considered unconventional. She adds: "The crisis has moved it to the centre. At its heart, the new approach will involve a renewed focus on crisis management and safeguarding stability through macroprudential policy – supervision aimed at countering risks to the financial system as a whole."

The future of central banking

Jeremy Warner of the Telegraph also has suggestions for the future of central banking: "Central banks are becoming tangled up in efforts to help national trade and competitiveness. The Bank of England, which seems to have prioritised a low exchange rate over the fight against inflation in its efforts to boost net trade, can hardly claim innocence."

The Rethinking Central Banking report last year recommended a global institution – an "international monetary policy committee" – capable of ‘aggregating the big picture and ensuring recalibration in national policies where necessary'. Perhaps the meeting in September could be the first step towards building that institution?


More on Mindful Money:

Should Libor be scrapped?

Eurozone: As Spain suffers is Portugal recovering?

Can the US housing market save the US economy?

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