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Tuesday, February 20, 2007

Central Bankers and Political Pressures

Sorry I've been away for a while: too much work chasing too little time.

Now this interview in the FT today with Barney Frank, Democratic chairman of the House financial services committee, is reasonably interesting. Frank is worried about any possible decision by the Federal Reserve, following the lead of Ben Bernanke, to introduce inflation targeting as policy:

In an interview, Mr Frank told the FT that Mr Bernanke “has a statutory mandate for stable prices and low unemployment. If you target one of them, and not the other, it seems to me that will inevitably be favoured.” Mr Frank noted that Alan Greenspan, the former Fed chairman, always resisted an inflation target on the grounds that it would reduce his operational flexibility. “I think Alan Greenspan was right not to do that in the 1990s,” Mr Frank said. The lack of a formal inflation target helped Mr Greenspan probe how low unemployment could fall without generating inflation.

This interview follows a piece in Bloomberg yesterday Central Banks Face Rising Pressure From Politicians which covers some similar ground at a more general level:

When politicians tried to pressure former European Central Bank President Wim Duisenberg, he used to say: ``I hear, but I do not listen.'' These days, a growing number of central bankers worldwide are hearing a lot -- and some are listening. The Bank of Japan refrained from raising interest rates last month in the wake of government pressure. The autonomy of banks from Ecuador to India is under attack. French presidential candidates are demanding the ECB meet a goal for growth.

All of this raises a number of issues. In the first place the US debate seems potentially to be a bit muddled if you look at the Frank quote, since in the first place there are the genuine loss of flexibility concerns of Alan Greenspan (which I personally have a lot of sympathy with) and then there is the targeting of unemployment as a separate issue.

Obviously any rate call decision involves some sort of trade off between inflation and growth, and this is always very tricky, but of course the issue that is generally being raised is a political one about the ability of the central bankers to take decisions that the politicians would like to take, and here, normally, I would side with the central bankers.

But things aren't really what they used to be on this front, since the central bankers, via the framework of the G7, have been embarked for some time now on a rate 'normalisation' process which often seems to belie both the inflation objectives (Trichet's citing of money supply numbers, rather than the actual inflation data, for example) and run the danger in some areas of generating sub-par growth (the eurozone, Japan).

Also the attempt to portray Japan's recent decision as a politically inspired one is strange, becuase on many counts it could be seen as responding to economic fundamentals, and Japan's inflation (which is again hovering dangerously close to the deflation level) would hardly call for a series of rate rises at this point.

The underlying problem is, of course, the level of global liquidity, and what to do about this (things like the carry trade) but if the central bankers persist with what many could consider to be an unreal strategy, then the danger really is there that they can lose credibility, and this would be, of course, the point where the politicians once more start to enter stage left. So the situation is a little preoccupying. One symptom of the problem was the recent G7 declaration on the Japan recovery:

“Japan’s recovery is on track and is expected to continue. We are confident that the implications of these developments will be recognized by market participants”

Belief in the Japanese recovery seems to have converted itself into more or less a statement of faith, with almost quasi religious undertones (although some would doubtless call this spin).

Interestingly Maria Demertzis, of the Nederlandsche Bank, has an interesting piece on Central Bank communication practices over at the new Euro Intelligence site. She clearly doesn't get into the underlying economic fundamentals aspect of the present situation, but she does have some timely points about the dangers of spin doctoring, and in favour of the ever present need for flexibility, an argument which is presented of course from a very different perspective than that of Berni Franks.

My point therefore, would be that it is perhaps difficult to keep doing a good job if you are left with little to no room for manoeuvre. Circumstance will some times warrant some flexibility. I would let the experts then decide when and how much that flexibility should be.

And the risk of spin-doctoring is augmented if the demand for communication exceeds the supply of information because your emphasis shifts entirely from the message you are trying to convey, to the way you are trying to convey it. My point is that one should be aware that requests for more transparency or for communication go hand in hand with a greater risk for miscommunication.

This is I would say the big issue, the central bankers have left themselves with little room for manouevre, and economic realities may soon force them to change discourse, whilst in the meantime they have fallen into the trap of engaging in a certain amount of "spin-doctoring". Worrying.

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