Central banks aren’t what they used to be – and the better for it | Business

We are used to thinking about the remit of central banks as focusing narrowly on price stability, or at most as targeting inflation while ensuring the smooth operation of the payment system. But with the global financial crisis of 2008 and now Covid-19, we have seen central banks intervening to support a growing range of markets and activities, using instruments that extend well beyond interest rates and open market operations.

An example is the US Federal Reserve’s Paycheck Protection Program Liquidity Facility, under which the Fed provides liquidity to lenders who extend loans to small businesses in pandemic-related distress. This, clearly, is not your mother’s central bank.

Now we hear calls to broaden this ambit still further. European Central Bank President Christine Lagarde and Fed board member Lael Brainard have each urged central banks to tackle climate change. Against the backdrop of the Black Lives Matter movement, US Representative Maxine Waters of California has pushed Fed Chair Jerome Powell to do more about inequality, including specifically racial inequality.

Such calls horrify central-banking purists, who warn that charging central banks with these additional responsibilities risks diverting them and their policy instruments from their primary objective of inflation control. They caution that monetary policy is a blunt instrument for tackling climate change and inequality, which can be more effectively addressed by taxing carbon emissions or strengthening equal housing laws.

Above all, the critics worry that pursuing these other objectives will jeopardise central banks’ independence. Central banks enjoy operational independence in order to pursue a specific mandate, because there is a consensus that the mandated objectives are best taken out of elected officials’ hands. But independence does not mean central bankers are unaccountable to politicians and public opinion. They must justify their actions and explain how their policy decisions advance the mandated objectives. Their success or failure can be judged by whether or not the central bank achieves its independently verifiable targets.

With a greatly expanded mandate, the relationship between policy instruments and targets would become more complex. Justifications for policy decisions would be harder to communicate. Success or failure would be more difficult to judge. Indeed, insofar as monetary policy has only limited influence over climate change or inequality, targeting such variables would be setting up the central bank to fail. And frustration over failure might lead politicians to rethink the central bank’s operational independence.

These arguments are not without merit. At the same time, central bankers cannot snooze quietly in their bunks in the face of an all-hands-on-deck emergency. Calls for central banks to address climate change and inequality reflect an awareness that these problems have risen to the level…