Good central banking should be boring: this was the mantra for most central banks in the pre-crisis era. It was borne on the back of the “Great Consensus” in monetary policy among academics and practitioners in which the “one policy tool and one objective” framework —typically the policy rate and price stability respectively — formed the cornerstone of the modern day central bank. Added to the mix was the concept of independence: the notion that monetary policy should be free from political influence, but accountable to government, making it more credible.
However, this orthodoxy was shattered during the financial crisis as central banks rushed to develop innovative policy responses after interest rates approached the zero lower bound (see Figure 1). In the years after the ‘Great Panic’¹ of 2008 the world of central banking changed radically:
One of the consequences of the financial crisis has been the disproportionate influence exerted by unelected central bankers. This has already caused elected government officials to challenge the democratic legitimacy of such a change:
Lessons from history show that legal independence is not always enough; central banks also need to ‘earn’ their independence by demonstrating institutional capability. To analyse what makes a capable central bank in this new, more complex era of central banking, we’ve drawn lessons from the 60s, 70s and 80s, the period which earned central banks their independence to conduct monetary policy in the first place. Our review suggests that successful central banks demonstrated their capability in three key areas: leadership, analytical competence, and communication. The real test will come when central banks have to manage through conflicting economic and financial cycles, balancing monetary and macroprudential policy (see Figure 6) settings, and communicating this effectively. Let’s hope they are ready.
¹“The Great Moderation, the Great Panic and the Great Contraction”, Charles Bean, 2009.