Introduction to Central Banking
Central bankers are the high priests of high finance, controlling high-powered money, commonly known as the monetary base, which includes currency in circulation plus commercial bank deposits with them. By buying government bonds from banks or the market, commercial bank reserves rise, improving market liquidity and reducing short-term interest rates. This process, known as quantitative easing, affects market sentiment and changes the whole interest rate curve.
History of Central Banking
The first central bank was created in Sweden in 1668 to finance the government and operate the bank clearinghouse. Initially, central banks operated under a simple rule: no gold, no monetary creation, due to the gold standard. However, governments soon discovered that central banks could fund huge deficits, risking inflation. To combat this, central bankers have the task of "taking away the punchbowl just as the party gets going," or telling the minister of finance when fiscal tightening is necessary.
The Role of Central Bankers
Central bankers seek to implement monetary policy to maintain price stability and financial stability, a task that requires autonomy and technical expertise. The relationship between central bankers and politicians has always been delicate, with most ministers of finance preferring friendly central bankers who share their political leanings. However, governments sensitive to market pressure recognize the importance of independent central banks, which can set monetary policy without interference.
Recent Developments
The Federal Reserve Bank of Kansas City’s Annual Economic Policy Symposium is a key event for central bankers, where they discuss the latest outlook for US interest rates. This year’s meeting was highly politicized, with US President Donald Trump calling for the resignation of Chair Powell and announcing the firing of a member of the Fed Open Market Committee. Despite this, Powell’s speech hinted at possible interest rate cuts, sending the Dow Jones to record highs.
The Importance of Independence
The independence of central banks is crucial in maintaining price stability and financial stability. The Fed chair, Paul Volcker, demonstrated this courage and independence in the 1980s by pushing interest rates to 20 percent to kill off US inflation. This move led to several decades of low-inflation growth. The Bank of England only gained legal independence in 1998, highlighting the recent recognition of the importance of central bank autonomy.
Conclusion
In conclusion, central bankers play a crucial role in maintaining price stability and financial stability through their control of high-powered money. While the relationship between central bankers and politicians can be delicate, the importance of independence is widely recognized. Despite President Trump’s pressure on the Fed, the facade of central bank independence is preserved, and market bulls assume that the Fed will be accommodative in the run-up to next year’s elections. Ultimately, the independence of central banks is essential in ensuring that monetary policy is set without interference, allowing for a stable and growing economy.
