Economic policy and central bank independence

Unfortunately, economic policy globally is settled on very unsettling fundamentals, and rather than fixing this, the blame for high level of inequality and increasing absolute poverty that this Neoliberalism oriented and over-board austerity based policy is creating – not to mention fast-unfolding of existential threats like climate change, and related ‘Pandemicene’ phenomenon that ‘market fundamentalism’ entrenched economic policy has contributed to – is being exploited by fringe political parties to mainstream themselves in power politics by wrongly doing politics of ‘xenophobia’ mainly against economic migrants.

Too much independence of central banks has created problems, whereby before the Global Financial Crisis (GFC) 2007/08, under the policy umbrella of Neoliberalism, lack of financial regulation resulted in allowance of borrowing into very risky ventures in the private sector.

After the GFC, rather than fiscal policy taking lead to check recessionary headwinds, both due to lack of multilateral support, sub-optimal efforts to enhance tax base, including reducing tax rates on higher income groups under an otherwise non-performing neoliberal thought process of ‘trickle-down’ positive impact in increasing economic growth and bailouts of financial institutions put pressure on domestic resource mobilization of countries, while too much quantitative easing in an over-board monetary policy role built-up debt issues for public sector.

In the wake of Covid pandemic shock, governments had to provide stimulus as country after country went into lockdowns, and the deep build-up of inflationary pressures as a result of global supply shocks primarily, all burdening countries, especially developing countries, a number of which, including Pakistan, are under severe debt distress.

There is a strong case of not only improving coordination of fiscal and monetary policy but also reining in central bank independence, mainly because it operates under an over-board monetary policy mindset, trying, in turn, over-employ interest rate instrument to not only control inflation but to target a rather very low inflation rate of 2-3 percent, which not only results in unnecessarily high growth sacrifice – hurting domestic resource mobilization effort – but also enhances debt distress.

For instance, apparently delay in reducing interest rate in the USA by the Federal Reserve has perhaps pushed US treasury to issue debt a lot more than it normally does.

An August 20, Project Syndicate (PS) article ‘The US Treasury’s backdoor stimulus is hampering the Fed’ pointed out in this regard: ‘Typically, the Treasury aims for 15-20% of outstanding debt to be in short-term bills, with the rest in intermediate- and long-term debt, called coupons. But this share has risen and remains well above any reasonable threshold: as much as 70% of new debt raised over the last year came from short-term bills, pushing the total well above 20%.’

While the article finds the Treasury at fault to have raised so much debt, the author believes that the lack of timely reducing the cost of capital, or policy rate, by the US Federal Reserve has mainly pushed the Treasury to take up more debt to invest in an economy which is slowing down quite considerably.

Hence, rather than the blame being placed on Treasury, it is the unreasonably low inflation target pursued by the US Federal Reserve that needs to be revised upward as reportedly indicated by economics Nobel Laureate, Joseph Stiglitz to be around 4-5 percent, given the economic transformation taking place globally in the wake of phenomena such as existential threats, artificial intelligence-led digitization, among others.

Moreover, to give an example of slowdown in US economy, a recent Financial Times (FT) article ‘Federal Reserve under fire as slowing jobs market fans fears of recession’ pointed out in this regard: ‘The employment report released on Friday showed companies added 114,000 positions across the world’s largest economy last month, significantly lower than the 215,000 average gain over the past 12 months. …The data comes two days after the US central bank opted against lowering its benchmark interest rate, which has remained at a 23-year high of 5.25 per cent to 5.5 per cent since last July. In justifying the decision, chair Jay Powell said the Federal Open Market Committee wanted to see more evidence that inflation is headed back to its 2per cent target before following through with any monetary policy pivot.’

A similar sort of over-board role of monetary policy is being seen in Pakistan where over-board monetary austerity – difference between policy rate (at 19.5%) and CPI inflation rate (11.1% for July) is around 8 percent – has resulted in high level of government borrowing from banks, since domestic resource mobilization is weak, both because of significant economic growth sacrifice due to over-board austerity policy, in addition to developing countries with weak democracies, like in Pakistan, does not allow in general quick increase in tax base, or putting greater taxes on the higher income groups.

Hence, there is a need for greater presence of government on monetary policy boards, like in the case of Monetary Authority of Singapore, which has, on the one hand, remarkable success in managing inflation and for better internalizing growth needs in monetary policy; on theother hand, reining in neoliberal policy in overall macroeconomic policy of government and the central bank.

An August 01, PS article ‘The limits of central-bank independence’ pointed out in this regard: ’Central-bank independence is often seen as a panacea to the type of high and persistent inflation that characterized the 1970s and early 1980s.

To many, it looks like a free lunch: disinflation and long-term price stability without any adverse effects on growth and unemployment. But defenders of central-bank independence have almost certainly overestimated its role as a guarantor of low inflation.

Consider a counterfactual: the Monetary Authority of Singapore has achieved an average inflation rate of almost 2% since its monetary-policy framework was introduced in the early 1980s.

Few central banks can match this stellar record, and yet four government ministers sit on the MAS’s board, and there is little doubt that the Singaporean government can control monetary policy if it so wishes. Singapore has achieved consistently low, stable inflation without a robust regime of central-bank independence.’

(The writer holds PhD in Economics degree from the University of Barcelona, and previously worked at the International Monetary Fund. His contact on ‘X’ (formerly ‘Twitter’) is @omerjaved7)

Copyright Business Recorder, 2024