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Central banks remain stuck in the trap

The true lessons of the crisis have yet to be learnt





Mervyn King has mounted a defence of inflation targeting. Monetary policy, he claims, is part of the solution to the crisis, not part of the problem.

This view was echoed by many official spokesmen at the recent IMF meeting in Tokyo.

Christine Lagarde praised the central banks.

There are quite minor differences of view among central bank watchers. Some economists argue that the Fed has shown the way, with its promise to inflate its balance sheet to infinite proportions – as big as the universe itself if necessary – to print the money that is supposed to create more jobs.

Others say central banks should be more cautious, that monetary policies cannot drive growth, that the ECB is right to insist in conditionality – quite a new thing in the history of central banking when applied to whole economies.

But whatever the disputes, the vast majority remain of the view that central banks should adhere to the monetary policy making model that they have followed for the past 20 years or so – inflation targeting with central bank independence and flexible exchange rates.

Even Masaaki Shirakawa, the thoughtful governor of Japan’s central bank, who is fully aware of the spillover effects of national policies, and asks for policy-makers to take them into account when making policy, defends the current models of central banks.

This shows, sadly, that the central bankers remain mentally trapped.

We will not be able to exit from the trap until such mental attitudes – such fixed ideas – change.

The crisis has shown that under the present international monetary system the sum of each country’s polices produces not just unwanted “spillovers” , but a breakdown of financial institutions, monetary fragmentation, and economic catastrophe.

That is the cost of policy-makers’ adherence to outmoded ideas.

Each country or central bank, following its mandate in an entirely enlightened, rational way, collectively produce insane results. Why is this?

Monetary policies, like economic policies in general, are national. No amount of coordination within the present set up can change that. In so far as international aspects can be taken into account, they already are by the time policy is fixed.

Each government and each central bank acting on its own tries to do what it can to pursue its national objectives. They all have mandates couched necessarily in national interest terms. No individual can be blamed for this. They are accountable to national parliaments.

But the result has been disaster for the world as a whole. That is the trap. That is what central bankers and even the IMF fail to recognise.

After all, they have all done well under the present system. It is the people who suffer.

So far we have endured five years of recession or sluggish growth, with no end in sight according to the IMF, while governments struggle. Central banks say they are doing all they can. They have inflated their balance sheet to an absurd degree, and now promise to blow them up to infinity.

Doing this may destroy the functions of money. It will not create jobs or sustainable growth. It will not create confidence in the private sector, the only route to growth.

Ben Bernanke, Mario Draghi, Mervyn King, Masaru Shirakawa and other presidents should reflect on the profound lessons of the crisis. Stop repairing something that is broken! They would conclude that financial globalisation has made their policy-making models anachronistic. They are out of sync with the needs of a globalized financial system.

Their best legacy to succeeding generations would be to admit that. Just as the ECB now admits that the design of economic and monetary union had serious flaws, which its leaders will try to remedy, so, at the global level, should intelligent economists and monetary leaders realize that the design of current policy-making models also has flaws, and that these are systemic.

Only a wholesale change of the system to a new set of rules can eradicate this. Until then, we will suffer repeated recessions.