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AB 2000 studies

Alain Boublil Blog

 

The central banks crisis

For more than forty years, developed countries economies went through a kind of permanent crisis, with some rare periods of remission, the last one having just finished with the brutal bumps which have affected financial markets at the beginning of February. Nothing more was needed by financial institutions and economists which have been silent just before the subprime crisis, to send alarmist messages. Worries had been generated by an interpretation, which will be proved wrong, of the intentions of a central bank after the publication of an economic indicator. That case shows the new position these institutions have taken. Their action is now attracting all the attentions. There are everywhere at the heart of the debate and it is relayed on them to guarantee the return of  major equilibriums and the financial stability of the countries even when it is found nowhere, in the different economic theories which are still teach today, such a capacity to meet these expectations and even less to play such a role.

It is Milton Friedman, during the Sixties, who thought he had described the link between inflation, growth and the evolution of the quantity of money. In managing it through the level of interest rates, it was possible to reach the objective of a growth without inflation. It was the duty of the central bank to watch over that. When prices increase was too high, the pressure on the demand obtained through rising interest rates permitted to correct disequilibrium. In order to avoid a new prices rise, the central bank had as an assignment to manage the evolution of the money supply. The critic of that monetarist vision of the economy was concentrated on its asymmetric character. It worked in one direction, restrictive policy, but not to support a rebound of the activity: it is not possible to force a donkey to drink when it is not thirsty. The remedy, in that situation, inspired by Keynes thought, was an increase of public expenditures. That opposition between Keynes who attributed to the state responsibility of guaranteeing the equilibrium the market was now able to reach by itself, notably regarding employment, and Friedman who entrusted that role to central banks has lasted during decades. Followers of the first one were teaching in universities on the East Coast, from Cambridge to Philadelphia, when their rivals were based in Chicago, next to a lake. From these different locations came their nicknames, salt water or fresh water economists.         

Central banks were also in charge of managing foreign currencies reserves of the States and of intervention on the exchange markets to avoid that rates diverge from the chosen levels under the fixed parities system. But that system blew out after the American decisions to suspend convertibility of the dollar in gold and to let its currency to fluctuate. France was confronted to this problem during the long period of transition which leaded to the creation of the European monetary union, indisputable reform to accompany goods and services exchange liberalization. It was almost impossible to manage a fixed parities system between European economies, the EMS, which coexists with currencies which, everywhere else, freely and roughly fluctuated as the dollar between 1979 and 1985. France suffered the consequences of that situation with the dollar appreciation as England, ten years after, when the country was the target of massive speculations in the perspective of joining the Monetary Union to which, at the end, it has to renounce.

The opening of capital markets and the freedom to circulate constituted the second major change for the central banks. Until then, parities changes were the result of trade balances. An imbalance was cured, in a sense or in another one, by a modification of the parity managed by the central bank of the concerned State. Progressively, it was  capital flows which became the dominant factors in the evolution of exchanges rates. They were influenced by different considerations like anticipations about interest rates evolution or the difficulties of the banking system in a State. The magnitude of financial transactions quickly surpassed central bank intervention capacities of the concerned country. The third change to which they have been recently confronted is that their main job, to reach price stability, which is the priority included in their mandate, has lost its purpose because inflation has almost disappeared. They had to define as a target, not to contain prices rise but, to the contrary, to act in favor of their rebound until an appropriate level. But it has never been proven that they have, at their disposal, the tools to reach that objective and it is confirmed by the current situation.

To that paradox has been added a new challenge after the 2007 crisis. States became heavily indebted to boost activity, following the Keynesian logic. But that policy did not bring the expected results and they found themselves short of means. Then they relied themselves on central banks action. But, in the same time, new prudential principles were instituted to reduce systemic risks through rules imposed to banks and financial establishments. These new constraints made more difficult the transmission to productive activities of the advantages created by expansionist monetary policies. Money was cheap but it was difficult for companies, especially the medium and small ones, to take advantage of it.

So, the impact on the real economy of monetary policies is today limited, whether the objective is already reached, regarding inflation for instance, or the used tool reveals itself inefficient as time goes by. The only real consequence of that new situation is that central banks have seen their role reduced to be the bankers of the States through a quantitative easing policy. These ones being more and more indebted have taken advantage from low interest rates in reducing the cost of their debt and they found more easily subscribers for their issuances. The impact of the monetary policy decided by the central banks has been transferred from the real economy to the financial markets, although it was not in their mandate.

These institutions are facing a situation of permanent crisis. The lesser declaration, a misunderstood or inopportune decision can set off on bond markets and even on stock markets fluctuations with never seen magnitude until now. They can have repercussions on the real economy. Speculative bubbles explosions can put in danger financial institutions and sink concerned countries into deep troubles. Stock markets collapse can provoke to households negative wealth effects which incite them to reduce their consumption or to renounce to acquire a home, which would send the related activities through deep difficulties capable to generate a recession.

We expect from central banks, due to traditional but out of date plans, an action and some results in line with a mandate focused on real economy, inflation, growth and employment, but most of their influence, for the better and for the worst, are on financial markets. They used to be, as a tradition, the banks of the banks. They became the banks of the States. This is less dangerous when they act in favor of a State, like the U.S. or Japan. It is much more complicated when the field of their interventions covers several countries which are not in the same financial situation, as in the eurozone.      

  

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