The Politics of Central Banking
Central bankers on both sides of the Atlantic are scrambling to explain to an increasingly restless public why they do what they do and why everybody would be worse off without those actions. Both the Federal Reserve (FED) and the European Central Bank (ECB) are increasingly becoming political bodies, forced by growing public scrutiny to build their own constituencies.
Last week, Federal Reserve Chairman Ben Bernanke agreed to be interviewed by Diane Sawyer on the ABC network. This is not the easiest venue for explaining the complexities of deflation, interest rates or, as Bernanke put it, the hows and whys behind “keeping the financial system stable and keeping it from falling apart — which is what we did.” As part of his most recent public relations offensive, Bernanke has just completed a series of lectures at George Washington University. A tentatively smiling Chairman is also on the most recent cover of The Atlantic, as “The Hero”. The magazine credits Bernanke with saving the global economy, and asks “So why does everybody hate him?”
Chairman Bernanke and his institution have so far failed to convince the public that they are doing the right things. In fact, they have been dragged into the mud of political campaigning, accused by both sides of wrong doing, either for not anticipating the financial crisis or for their response to it. Conservatives have turned Bernanke into cannon fodder. Even the more moderate of the Republican presidential hopefuls, Mitt Romney, has decided there is more to gain from criticizing Bernanke than from keeping quiet. He, too, now says that he would replace Bernanke once his term expires if he were to become president. Others are even more scathing in their criticisms − Ron Paul has based his whole campaign on his plan to abolish the FED altogether.
Things were very different in the nineties, when then FED Chairman Alan Greenspan inspired journalist Bob Woodward to write a bestseller titled “Maestro”. In the wake of the Asian financial crisis, Time Magazine turned Greenspan into a member of a small “Committee to Save the World”. At the time, the FED was a powerful and trusted institution. Today it is still powerful, but it has lost that trust. The hard landing is only in part the result of the FED’s own mistakes. Paradoxically, it is more a reflection of growing disenchantment with the political class. It is political gridlock in Washington that has unintentionally pushed the FED onto the main stage, where it can no longer hide from continuous public scrutiny. If democratically elected politicians fail to make decisions, “technocratic” institutions such as the FED, which end up stepping into the void, must bear the brunt of public discontent. And programs such as TARP, QE2 or operation twist don’t easily lend themselves to neat packaging for general consumption. Moreover, if seen through a moral lens, those policies can easily be perceived as highly suspicious. To borrow a phrase often heard these days, they merely “help out those who got us into the mess in the first place.”
“Moral hazard” is what is increasingly getting the European Central Bank into trouble as well. It, too, was forced to step into a void left by European politicians, who were, for too long, unable and unwilling to take the necessary steps needed to address the crisis in the euro zone. The ECB, much like the FED, now risks becoming a punching bag for all those − particularly in Germany − who think that it is rewarding bad behavior by both banks and profligate peripheral countries.
Since its inception in 1999, the ECB has tried to prove itself a worthy heir to the German Bundesbank. For decades, Germans viewed the Bundesbank as an almost sacred institution. It was the only organization tasked with fighting inflation, one of Germany’s historic demons. Winning the war against inflation effectively turned the Bundesbank into the ultimate custodian of Germany’s wealth, more trusted than the country’s politicians. For the ECB, it was a hard act to follow, not least because the Bundesbank never morphed into the ECB. The Bundesbank is still there, and it makes itself heard when it disagrees with what euro zone central bankers decide in Frankfurt. When the public mood sours, it is the Bundesbank that Germans turn to for guidance, not the ECB, which is still considered “foreign”. Not surprisingly the ECB’s new head, Mario Draghi, has repeatedly tried to assert his German credentials, most recently by allowing himself to be featured on the popular and populist German daily “Bild” with a Prussian helmet. Draghi was forced into the public relations offensive by open criticisms of recent ECB actions from his counterpart at the Bundesbank, Jens Weidmann.
Draghi’s main job is to address the needs of the euro zone’s financial system and, in particular, peripheral economies such as Spain and his native Italy, while keep the Germans firmly on board. Draghi’s balancing act is at least as difficult as Bernanke’s in the U.S.
However, there are notable differences between Washington and Frankfurt. The influence of the Bundesbank can have a short-term impact on the ECB’s actions. It can slow the ECB down if, and when, it needs to resort to non-standard measures to address worsening economic conditions across the euro zone. Draghi needs to continue to be able to react pragmatically to changing conditions now. The FED does not yet face similar constraints. Its potential trouble lies further ahead. In fact, Bernanke’s push to make the FED more transparent is the beginning of a campaign to save the institution from being emasculated by future legislators who might be keen on putting the Federal Reserve on a tight leash.
But ultimately, in both cases, the central banks are fighting for their independence – from populism in the U.S. and from German anti-inflation orthodoxy in Europe. Both the FED and the ECB believe that they need the wider support of the general public. Of course, they now run the risk of being dragged even further into the mudslinging reality of the political arena. Nevertheless, they have obviously concluded that it is a risk worth taking.