British economist Charles Goodhart says that central banks do not need to set “official” short-term interest rates. Why? Anybody, he says, could do the job as well or, perhaps, better.
Prof. Goodhart’s judgment could be relevant to Bank of Canada Governor Mark Carney in his role as regulator-in-chief of the Swiss-based Bank of International Settlements, the central bank of the central bankers. Was not easy money a significant cause of the financial meltdown of 2008? Was not the U.S. Federal Reserve Board the prime supplier of that easy money?
With a career as an academic economist at the London School of Economics and as a monetary policy functionary at the Bank of England, Prof. Goodhart speaks with authority on the history, and performance, of central banks. Indeed, when he addressed an audience of central bankers last year in Lucerne, Switzerland, Mr. Carney was in the audience.
“Setting official interest rates is not essential for a central bank,” Prof. Goodhart insisted. “In many countries and for many decades, it was done by a politician, not the central bank.” A committee of economists could do the job, he said, or, alternatively, “a coven of Druids casting runes over the entrails of a chicken.” It’s simply not important, he said, who does it.
One less dismissive alternative would let the markets set short-term rates – as they decide all longer-term rates. Prof. Goodhart didn’t discuss privatization of the task (although it’s hard to say why the markets would do a worse job than a coven of Druids). For his part, he favoured hiving it off from the central banks and giving it back to finance ministry bureaucracies.
In assessing the performance of central banks, Prof. Goodhart divided the modern era into three periods: Victorian (1840-1914), epitomized by the gold standard; government control (1930-1970), epitomized by government control (with socialism “waiting in the wings”); and market control (1980-2007). This latter classification is problematic. As an epoch of monetary management by politically independent central bankers, “market control” is a misleading phrase – given the debt-expanding role retained by governments. (For one example, see Europe.) Prof. Goodhart would have come closer to the mark by classifying his three epochs as the Victorian era, the FDR era and the Greenspan era.
Nevertheless, using his own terminology, Prof. Goodhart ranked the Victorian era as best performer, with the fewest bank crises and currency crises. With twice as many crises as the Victorian era, the markets era scored second best. With three times as many crises, the government era scored worst.
Prof. Goodhart anticipated that central banks will now cede regulatory authority back to politicians – because the great problem of the next epoch, he said, won’t be inflation. It will be debt management, primarily a political function. (In Britain, debt management fell to the Bank of England for more than 300 years; in 1997, Labour Chancellor of the Exchequer Gordon Brown presciently handed it to a Debt Management Office.)
The superior record of the Victorians, Prof. Goodhart said, didn’t rest solely on the gold standard. It rested on conservative moral and economic assumptions that the modern mind repudiated.
Victorian-era banks, for example, held a much larger proportion of deposits as reserves for financial crises. In 1880, U.S. banks held 24 per cent of deposits as reserves; British banks, 17 per cent. In 2000, U.S. banks held only 7 per cent as reserves; British banks, 5 per cent.
And Victorian-era governments routinely ran small budget surpluses in peacetime years; they generally ran deficits only in wartime. (How Keynesian!) They deemed the purchase of government debt – “quantitative easing” – to be morally and economically reprehensible.
Prof. Goodhart’s conclusion: “With the benefit of hindsight, a populist frenzy now blames the excesses of bankers for putting the system at risk, and the weakness of … regulators/supervisors for allowing it to happen. But at the time, neither bankers nor regulators … had any appreciation of the risks that were being run.” Blame it all, perhaps, on the forgotten virtues of yesteryear.
In a provocative paper last month (titled Europe After the Crisis), Prof. Goodhart proposed that the presidency of the European Commission be made an elected post, so that “Europe’s president” would hold a democratic mandate to unify the disparate economic policies of the European Union countries – presumably with the help of a ministry of Druids.