Should central banks be policy makers of last resort?

25th June 2012

In an interview with the Wall Street Journal, Stephen Cecchetti, head of BIS's monetary and economic department, praised bank regulators for implementing capital rules, known as Basel III, and for starting to address liquidity regulation.

However, "I would have hoped that the real side of the [global] economy would have recovered more strongly and there would have been significantly less reliance on various kinds of official support," he said.

Notably, global policymakers have become too dependent on their central banks to resuscitate their flagging economies, repeating a warning that was made in the BIS's annual report.

"There is a growing risk of overburdening monetary policy," said the Swiss-based bank known as the central banks' central bank. "Failing to appreciate the limits of monetary policy raises the risk of a widening gap between what central banks are expected to deliver and what they can actually deliver. This would complicate the eventual exit from monetary accommodation and may ultimately threaten central banks' credibility and operational autonomy," the BIS said.

Those worries were reiterated by Mr. Cecchetti. Central bankers "have been made the policymakers of last resort. That's not where they should be. They can't implement structural reforms, they cannot put fiscal policy on a sustainable path. This reliance on the central bank makes it so the other actors…get to wait a little bit" in implementing reforms.

Yet some economists and politicians have argued that central banks have been too hesitant, leaving their economies hanging by a thread as slow growth and higher rates of unemployment take full effect in the wake of the devastating financial crisis. For instance, many thought that the Federal Reserve should have rolled out another round of quantitative easing (QE3) at last week's two-day policy meeting. Instead, the fed opted to extend its program of ‘Operation Twist' which involves selling short-term securities and buying longer-term bonds to push down interest rates even further.

On the flip-side, policymakers, particularly in Brussels and Berlin, answer back  by claiming that curing the ills of slow growth and high debt lies now with government deficit-cutting and policy changes that can only be made by elected politicians.

And Jaime Caruana, the general manager of the Swiss bank, who sits firmly in that second camp, identified three major risks with continued monetary easing:

First, the prolonged monetary stimulus might make structural or fiscal adjustments seem less urgent. Second, the financial-stability risks of protected low interest rates could be significant as financial firms and investors shift to riskier assets in search of higher yields. And, third, central banks may find it difficult to "calibrate and implement the tightening of monetary policy that will inevitably be required," which, in turn, could produce another credit bubble or an outbreak of inflation.


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