Are We Asking Too Much of Central Bankers?
If you had to guess, what would you say are the top priorities of the world’s foremost central bankers?
Economists like myself would say maintaining stable prices and achieving maximum employment should top the list, as these are issues which dominate discourse among central bankers and what many first-world governments legally mandate. But last week, the debate over the role central banks should play in society shifted toward a quite surprising domain: global warming.
During her confirmation hearing before British parliament last Wednesday, Christine Lagarde faced questions pertaining to how she—the predominant choice to succeed Mario Draghi as president of the European Central Bank—would address climate change and its long-term impact on the European economy.
Now when I heard this, I was not at all surprised; members of parliament will seize any opportunity to pass the buck on issues they themselves have failed to addres. Why would global warming be any different? But, to be fair, it’s not just parliament; politicians around the world do much of the same thing. There is a reason why central banks have become the only game in town, and it’s because politicians fail to act on important economic issues, forcing central banks to come in and use their tools, which are oftentimes highly inappropriate, to solve a problem that should have already been addressed by elected officials.
Despite this reality, there is still a contingent who believe central banks can, and should, do more. Some believe, given an ever-changing geopolitic and the global trend toward political inaction, that central banks should undergo continual audits to determine the most pressing issues facing a country and use any and all resources at their disposal to solve them.
But central bankers can't build roads. Nor should they. They can't oversee research and development of cancer drugs or monitor food quality. There have been times when expanding the scope of central banks has served society well and times when doing so took away from the true mission of central banking—trying to solve global warming certainly falls under the latter.
Having said this, I must note that broadening a central bank's scope is not always ill advised policy. Take, for instance, the US Federal Reserve. When the Fed was established in 1913, it was designed primarily to create reserve banks, ensure an elastic currency, and establish a more effective way to supervise US banking. But in 1977, after Congress failed to address low growth and high inflation seen throughout the US economy, Congress added what is now known as the dual mandate, a provision directing the Fed to dynamically evaluate economic factors and prescribe policies which ensure low inflation and maximum employment. And over the years, the Fed has been quite successful in achieving those goals, but this success has only led to calls for the Fed to broaden its scope further. For example, after witnessing the vast financial hardship of the Great Recession, some policymakers proposed adding a third Fed mandate of ensuring financial stability. This could mean that the Fed would purchase equities or other securities if financial markets posed a significant threat to overall health of the economy. But that idea—along with other notable proposals that have come along in recent years—is riddled with perverse incentives that may, in fact, yield more harm than good.
For instance, what impact would a financial stability mandate have on risk taking? If Wall Street has a government backstop for market downturns, what is to stop players from leveraging up and taking exorbitant risks, knowing the government will to come to rescue them when things go south? More importantly, how would additional risk to the economy affect the Fed’s ability to achieve maximum employment and stable prices if another 2008 size crisis hit?
But looping back to the global warming questions posed to Christine Lagarde, should the ECB really be the institution responsible for addressing the financial impacts of global warming, and if so, would this in any way affect the ECB's ability to achieve optimal monetary policy in the region? Because unlike the US Federal Reserve, the ECB has only one policy mandate: maintaining stable prices. There are many reasons for this, but primarily it’s because the Eurozone is a monetary union consisting of differing economies with various, and often times diametrically opposing, economic agendas. Applying any rule effectively to an economic zone of that size is difficult.
So while I’m confident Parliament has good intentions in asking the ECB to support greener capital intensive projects, it’s just unlikely that the ECB can do this effectively, and with its limited toolkit, it’s unlikely that their efforts will promote green financing to the extent their actions actually incentivize green investment across the entire region. Yes, the ECB can add “green" securities to its large scale asset purchases (something Lagarde said she is willing to consider) but there are so few of these securities relative to other, safer assets that more adequately serve the ECB’s agenda.
My point is that there are problems central banks are well equipped to solve; global warming isn’t one of them. I don’t want to take anything away from how pressing an issue global warming is, but I feel we are losing sight of the primary mission of central banking in hopes of fixing an issue unsuitable to the competencies of central bankers.