On monetary governance

Central banks are on trial these days. They have been blamed for much of the global financial crisis that broke out in the autumn of 2008. Before then, Wall Street had been a massive gravy train in which young traders barely past their teens were raking in millions of dollars in salaries and bonuses. A few hedge fund managers took home personal emoluments in the region of a billion dollars each. It was a new gilded age for the big investment banks – Goldman Sachs, Morgan Stanley – the lot.

During his time as chairman of the Federal Reserve, Alan Greenspan was seen as the wunderkind of high finance. The markets hanged on his Delphic pronouncements as though he was one of the gods of Olympus. Some claimed they could divine from the colour of his tie where the wind would blow. Greenspan’s career shows how finicky fame could be. From being a hero, he has become more or less a villain. His lax monetary policies were said to have spurred the bubble in asset prices which got everyone in the investment industry to behave with the licentiousness of drunken sailors.

The German playwright Bertolt Brecht once observed that famine cannot take place without the grain merchants knowing a thing or two about it. The money-changers and speculators must know something about the path that has led us to the current global predicament. American pioneer industrialist Henry Ford noted that if people really knew how bankers made money, “there would be a revolution before tomorrow morning”.

Indeed, the great Thomas Jefferson believed that “banking institutions are more dangerous to our liberties than standing armies”.

We may decry usury, but we will always need bankers. If banks are important, central banks are even more so. It is they that set the rules of the game – the lenders of last resort. In a manner of speaking, central banks are magicians who can conjure gold out of thin air. This science of alchemy belongs only to the Elect. We call it seignorage. As a result, central banks wield enormous power. When they misuse their power, entire nations are imperilled.

In our age of upheaval, central banks have been called upon to bail out ailing behemoths and to provide resources to restore the equilibrium. Monetarism, the dominant ideology peddled by the Bretton Woods Institutions, with its penchant for high interest rates, limited spending and a restrictive role for government, has been kept at bay. The ghost of John Maynard Keynes is being resurrected through the increase in public spending and varieties of stimulus packages aimed at boosting national aggregate demand. The printing presses are back to work, as quantitative easing has become the new elixir that purportedly guarantees survival.

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For much of the past decade, Japan, for example, has suffered from the problem of deflation – the phenomenon of rapid decline of prices leading to massive contraction in production and asset values. The outgoing governor of the Bank of Japan, Masaaki Shirakawa, considered it anathema to undertake quantitative easing, fearing it would impose a further squeeze on wage-earners, particularly the middle class. About a month ago, Shirakawa left in a cloud. The new prime minister of Japan, Shinzo Abe, had decided to appoint someone else to the job, in the person of the respected former president of the Asian Development Bank, Haruhiko Kuroda. The latter had been a long time critic of Shirakawa’s cautious approach to monetary policy management. Kuroda has hit the ground running, committing the Bank of Japan to embrace quantitative easing and other bold measures to rev up the engines of Samurai capital and industry. Some whopping ¥50 trillion is being planned in annual financing.

In Japan, Europe and elsewhere, monetary governance is at the heart of the business of central banking. If left to their own devices, politicians would print and spend money as though there were no tomorrow. An autonomous monetary authority able to stabilise prices, sustain the value of the national currency and ensure financial stability is therefore seen as the sine qua non for long-term prosperity. Entire nations have been ruined when monetary governance fails to work as it should. The German hyper-inflation of the inter-war years is a classic case in point. It was a lesson that compelled the German people to acquiesce to the need for an independent Bundesbank which has been at the foundation of Germany’s miraculous recovery.

Prudent monetary governance requires commitment to certain key imperatives: price stability, a strong currency, stable exchange rates, affordable credit for the real sector and commitment to economic transformation and job-creation. Price stability is paramount. But it must be pursued alongside growth, employment and financial inclusion. Monetary authorities do not always have to agree with the government. But they must not behave as though they are a parallel government.

The distinguished Indian economist, Asuri Vasudevan, has drawn our attention to the role and importance of monetary governance in his new book, Monetary Governance in Search of New Space (Academic Foundation 2012). A former senior official of the IMF who also served as an executive director at the Reserve Bank of India, he was until recently adviser to the governor of the Central Bank of Nigeria. It was my good fortune to have worked with him on the Monetary Policy Implementation Committee at CBN.

The entire six chapters of the book are studded with golden nuggets of insights and wisdom about how monetary governance can contribute to enduring welfare. He sees monetary governance in terms of the institutional arrangements necessary to ensuring the sound functioning of a country’s economy. Drawing from his wealth of international experience, he wisely counsels that monetary authorities must always proceed with caution. A good central banker keeps a cool head when everybody else is losing theirs. Quick panaceas may impress the gullible, but enduring solutions must be founded on knowledge, sound macroeconomics, flawless policy analytics and deep awareness of changing national and global conjunctures.