Central bank blues

Janet Yellen has hardly dazzled, but her successor is unlikely to either

I’m not a fan of Janet Yellen’s time as chairman of the Federal Reserve – but then again, I’m not a fan of central banking in general. Her recent predecessors Ben Bernanke, Alan Greenspan and Paul Volcker were all flawed in their own ways, helping to generate catastrophic booms and busts with their monetary policy blunders. My problem is not really with Yellen, but with her profession.

Starting with Greenspan, central bankers began to fancy themselves as economic gods: they thought that they could manipulate monetary policy to create a permanent expansion and continuously booming stock market. Instead, they created gigantic waves of asset mispricing. They also embraced moral hazard: they ended up in a permanent dance with the markets, in effect promising to bail them out if ever they started to slow down.

The problem is that central banks’ primary task is impossible to get right: to centrally plan the supply of money and official interest rates. The argument against classic top-down resource allocation, first made properly by Ludwig von Mises and FA Hayek, holds in this area.

Monetary socialism is as faulty as stateowned, monopoly widget socialism. It falls foul of the “knowledge” problem.

Without property rights and competition, there is no market generated information, no prices that genuinely reflect a myriad of variables about tastes, scarcity, supply and demand. Hence central banks, with the best will in the world, will always get it wrong, and either supply too much or too little money, and set interest rates too high or too low. They will be behind the curve when it comes to recessions or booms. But while central banking will always be a disappointing quest, this doesn’t mean that it cannot be improved upon. Its practice these past few decades has been catastrophic. The Bretton Woods post-war system’s demise went hand in hand with a terrible bout of consumer price inflation. Volcker helped tackle this but paved the way for the macroeconomic errors that blighted the late Eighties.

Central banks were also to blame for fuelling the dotcom bubble, for over-reacting to the Millennium Bug and 9/11, and for the massive debt bubble of the 2000s. Instead of pushing up consumer prices, the excessive liquidity poured into asset prices, including bonds, equities and property. Central banks, led by the Fed, pumped monetary steroids into commercial, investment and shadow banks, extended endless implicit guarantees and too-big-to-fail commitments, encouraged extreme risk-taking and then acted surprised when it all ended in tears.

Since then, central bankers have continued to get it wrong. A decade after the financial crisis, we remain stuck with emergency policies that were right in 2008 but are deeply counter-productive today. One result is that there has been insufficient liquidation of dud companies and projects, and productivity has suffered. This is one reason why real wages have been so depressed.

Another, even more pernicious problem, is that those who own assets have done well from ultra-low interest rates, but those seeking to buy homes have been priced out. This has exacerbated divisions between old and young and asset-rich and asset-poor, with immensely negative political repercussions. In the UK, the rise of Corbyn can directly be traced to the side-effects of central banks’ obsession with ultra-low monetary policy. Of course, the Bank of England is at fault here, but it is clear that it has partly been influenced by the Fed.

Last but not least, central banks across the West have crippled savers and damaged the business models of many financial services firms, not least retail banks. Pension models have been upended, with annuities becoming largely impractical. As to pension fund deficits, they continue to divert funds away from corporate investments.

So what is to be done? The next big change could come when Donald Trump appoints a new Fed chairman. Hiring a radical, willing to break with the failed consensus of the past few decades, could be Trump’s legacy. The question is: will he? Jerome H Powell, a Fed governor who has backed every decision since 2012, is one frontrunner. It would be best to rehire Yellen rather than simply appointing another identikit chairman. Appointing John Taylor of Stanford would make a much bigger difference: he’s a radical who believes in a much more aggressive policy.

There are other, even more revolutionary options, but the ball is now in Trump’s court. He should go for broke, but if he doesn’t then he might as well stick with Yellen. allister.heath@telegraph.co.uk

‘Central banks will always get it wrong and supply too much or too little money’