Central banks at bay: A looming currency war?  

Hasnat Abdul Hye   | Published: July 13, 2019 21:52:22 | Updated: July 17, 2019 20:56:28

Time was when members of the blue-ribbon committee of central banks sat in wood-panelled meeting rooms and decided monetary policy framework on quarterly basis. Basking in independence from political pressure, the grey eminence of the financial world took into account the rate of economic growth, employment figures, wages, price levels, consumer, expenditure and balance of payments to arrive at their policy decisions. Though the parameters and ambit of monetary policy was wide-ranging, the main focus of policy making by central banks was the benchmark interest rate that determined the cost of borrowing of financial institutions and by implication, of investors. This familiar traditional role of central banks in developed countries and to a lesser extent in developed and emerging economies received a severe jolt after the global financial meltdown in 2008. Though originating in America, where the epicentre of the great financial upheaval took place, the shock waves of the crisis shook the very foundations of the economies of other developed economies and affected developing and emerging countries through the transmission mechanism of globalisation.

Seemingly, flying in the face of conventional wisdom and departing from normal monetary policy making, central banks in developed countries assumed a more assertive role in jumpstarting the floundering economies that gasped for breath from lack of financial liquidity in the wake of the financial crisis of 2008. Having started the domino crash in the financial sector with subprime mortgage loans, America took the lead in reviving the recession-bound economy with the Federal Reserve Board (Fed) launching an unprecedented programme of loose money regime, euphemistically described quantitative easing (QE), by injecting money through purchase of billions dollar worth of bonds from cash-strapped banks. This was accompanied with a nominal basic policy rate of interest that remained below 1.0 (one) per cent for almost a decade beginning from 2008. It was only in 2018 when macro-economic figures of growth, employment, wages, inflation, equity prices and consumer expenditure showed that the economy was in the re-bound that the Fed nudged the basic interest rate up by small percentages in three installments. The Fed continued with that policy of incremental increase in the benchmark interest rate until the American economy caught a whiff of headwinds caused by the slapping of tariffs on Chinese imports by Trump administration. As it was mulling over whether to take a pause or lower the interest rate, tremendous pressure was brought to bear by White House for immediate reduction of basic interest rate and continuation of the QE. The Fed, under the independent-minded chairmanship of Jerome Powell, resisted the pressure and bided for time to see how the economy panned out in the short term. Furious at not having his way, President Trump is now about to appoint two new candidates of his choice as governors of Fed to ensure that Fed does his bidding without soft-pedaling. With these appointments the independence of Fed is going to be a thing of the past, making it a handmaiden of the executive branch for as long as Trump is in power.

If it was for the sake of jump-starting an anemic economy with easy money and the situation was as critical as in post-2008 period, the Fed would have obliged Trump even without pressure, overt or covert. Though American economy is now facing a potential headwind following the start of a tariff war, it may yet be averted if the trade negotiation with China is concluded successfully. Hence the Fed has not felt the urgency of repeating the same policy of easy money that it had initiated following the financial crisis in 2008. Because of this and the knowledge that President Trump wants Fed to re-visit QE and lower the  basic interest rate not because of slowdown in the economy but to use monetary policy as a weapon of choice in his confrontation with trading partners, has made Fed to wait and see. That pursuit of easy money policy at a time of slow but steady recovery of the economy is not only unwarranted but it may also initiate a currency war globally in line with Trump's misbegotten decision to play eyeball to eyeball with trading partners has also discouraged Fed from reckless use of monetary policy. This independent and pragmatic stance of Fed may change once its management comes under dominance of pro-Trump governors.

If America shows the predicament of Fed in independently pursuing its traditional policy to stabilise price levels and provide an enabling environment for sustained economic growth during a period of normalcy, the central banks in other countries have not been immune from the contagion of interference from the executive branch. In the eurozone in European Union (EU), a monetary policy, similar to the one introduced by Fed, was set in operation by the European Central Bank (ECB) to address the fallout from the 2008 financial crisis that buffeted the EU economy. The easy money policy, introduced in the aftermath of the crisis, was wound up by ECB about the same time as in America, after it had successfully played its role. But under pressure from the politicians in the debt-ridden countries of EU to re-introduce easy money policy, the ECB has now reluctantly agreed to defer tightening of basic interest rate. Mario Draghi, the President of ECB, announced last week that even the easy money policy of buying bonds with printed money may be on the cards in the near future. After Fed, this will be the second case of a central bank (ECB is likened to one) succumbing to political pressure.

Away in the Pacific region, the Bank of Japan (BOJ) has not fared better in terms of operational independence. Having been hand-picked by Prime Minister Abe, the governor of BOJ, Hiroshi Kuroda readily agreed from the beginning of his tenure to use monetary policy for implementing two important policy decisions in what has come to be known as Abe-nomics viz. injection of printed  money in the economy and inflation-targeting at 2.0 (two) per cent. Although Japanese economy has recovered from stagnation inflicted by the scourge of deflation and the economies on the re-bound the independence of BOJ has not been restored. By issuing a statement in parliament recently, Prime Minister Abe made it amply clear that he will continue to use monetary policy to guide and steer the Japanese economy for as long as he is in power.  Other prime ministers who preceded Abe did not show any inclination to uphold the independence of BOJ, nor are his successors likely to depart from the tradition of using monetary policy as an instrument to achieve goals set by the government.

If the operational independence of central banks of developed economies, including EU and Japan, has been compromised or is under threat as in America, the situation in emerging and developing economies is no better, perhaps worse. In India the governor of Reserve Bank of India (RBI) Mr. Patel, was force to resign in December last year after a high-profile stand-off with the Modi government over formulating monetary policy, particularly setting the basic interest rate. Resisting pressure from the government to reduce interest rate and to soften the stance on loan defaulters, one of the Deputy Directors of RBI, Mr. Acharya resigned last month in protest.

In Turkey, President Erdogan did not wait for niceties and summarily dismissed the governor of Central Bank of Turkey because of his dithering over reduction of interest rate. He has now been replaced with a more malleable and compliant President of the bank who promptly reduced the basic interest rate while declaring that the policy of the bank was to contain inflation.

According to a Reuters news published on  June 03, the central banks in  37 (thirty seven) developing and emerging countries reduced their basic interest rate for the second time following three rate cuts earlier in 2018. This cuts followed a cycle of tightening money supply with the help of high interest rates. Given the state of democratic governance in countries like Pakistan, Kirghystan and Kazakhstan included in the list of  37 (thirty seven) countries mentioned by Reuters, it can be safely assumed that the central banks played second fiddle to the executive branch in formulating monetary policy.

The brief review above of the working of central banks in respect of formulating monetary policy across the globe makes it amply clear that their operational independence is either compromised as a matter of routine or is interfered with in times of crisis by governments. As long as monetary policy is favoured by governments on economic considerations central banks have no problem in agreeing. In fact, during such occasions central banks take emergency measures without waiting for prodding from the government as the Fed and ECB did following the 2008 financial meltdown. But governments are likely to interfere with the policy-making functions of central banks even without a crisis, simply for political reasons to gain popularity. A sinister example of such interference is the overt attempt by President Trump to influence Fed's monetary policy with a view to using it as a weapon of choice to achieve his goal of `America First'. This is a dangerous move as it is likely to trigger retaliatory measures by other countries unleashing a currency war. Together with tariff war that has been initiated by President Trump, a currency war will deal a severe blow to the global economy from which it will be difficult to recover.



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