In one of the most important challenges in decades to the orthodox economic policies of central banks, UK Labor Party Leader Jeremy Corbyn is saying he will push for a revision of the formal objectives of the Bank of England. In doing so, he has reopened a broader debate on the proper roles and functions of central banks more generally and what is their responsibility in supporting the achievement of human rights.
Until recently, save for a few central banks, this question has generally been neglected in public discourse and was long considered to be the prevue of academics and policy wonks, such as Gerald Epstein, Professor of Economics at the University of Massachusetts, Amherst. Epstein has long criticized the single-mindedness of contemporary central bank policy that focuses solely on keeping inflation low. Instead, he has championed the idea of expanding the tools in the policy “toolbox” of central banks so they can go after a broader number of economic and social goals. “Central banks should have more objectives than just keeping inflation low,” says Epstein, “and to meet more objectives, or targets, central banks have at their disposal the use of more instruments.”
Not only has the remit of central banks been too narrow, but there is a related debate about who should control or influence central bank policy decisions – and who should not. The dominant strain of thinking in conservative and “orthodox” economics of the last few decades believes that governments and politicians should not have any control over central bank policies, such as the setting of interest rates. The reasoning is that because they are susceptible to political pressures and want to appease voters prior to periodic elections, governments would interfere in monetary policy in ways that might risk long-term economic and financial stability just to get re-elected in the short-term. So the leading idea of the last few decades was to take control over central bank policies away from governments and set up “independent” central banks instead, which would be staffed by professional technocrats, whom it is believed would be “above politics” and would simply apply standard “rules” objectively. And the main rule they need to follow is to keep the money supply in check so as not to allow inflation to ever rise too much.
The only problem with this thinking is that, in the real world, while the “objective technocrats” at “independent” central banks may have become insulated from governments and political pressures, they have instead become captured by the private financial sector, which has its own goals for setting interest rates. This raises the question if central banks could ever be truly independent or truly objective in their tasks.
After three decades of narrow minded inflation-targeting and central bank independence being considered the best approach, Jeremy Corbyn in the UK, and many others, are now saying enough is enough – it is time for a rethink about the roles and functions of central banks, particularly in an era of worsening economic inequality and the increasingly lop-sided power that the financial sector has come to wield over the real economy in many countries. Now Corbyn, and his shadow chancellor John McDonnell, have set sights on reforming the formal mandate of the Bank of England to make it focus more on stimulating GDP growth, creating jobs and increasing wages, as well as keeping inflation in check.
While stopping short of undoing the BoE’s formal independence, McDonnell says the Labor Party “will launch a debate on expanding that mandate to include new objectives for its monetary policy including growth, employment and earnings,” and a more “active” monetary policy to stimulate demand where necessary, and establish an economic advisory committee to advise on policy with members including Joseph Stiglitz, Thomas Piketty and Mariana Mazzucato.
Also at play in the new reconsideration of central bank policies has been a rethinking of the Philips Curve – a theorem in economics which states that when unemployment gets too low, inflation is in danger of rising and so interest rates must be raised in order to prevent the expected uptick in inflation. But real world developments over the last decade have brought the validity of Curve into question – as many countries have seen low unemployment without the expected increase in inflation resulting. This downplaying of the importance of the Philips Curve can help understand recent moves by the US Federal Reserve and other central banks to keep interest rates low even as unemployment has come down – overturning the orthodox approach of earlier generations of central bankers.
There is growing acceptance that rather than obsessing solely on the inflation rate, monetary policy could be used more flexibly to more gradually recalibrate the balance between these two economic indicators (unemployment and inflation) as the business cycle proceeds: when inflation is low, the top priority should be to reduce unemployment to the lowest possible level; and at the same time there should no reason for central banks not to also pursue other worthwhile goals as well, such as boosting job creation or GDP growth, until excessive inflation becomes an imminent danger.
In other words, if you believe in the traditional Phillips Curve and see how unemployment has come down in the US, you might well think that inflation should be taking off any day now and be expecting the Fed to therefore raise interest rates. But two Fed governors, Lael Brainard and Daniel K. Tarullo, have recently argued against such a rate move. Ms. Brainard said that the Phillips Curve relationship was “at best, very weak at the moment.” Mr. Tarullo said that it was “probably wise not to be counting so much on past correlations, things like the Phillips Curve, which have not been working effectively for 10 years now.”
If the traditional fixation on the Philips Curve is increasingly in doubt as a reliable guide post, and there now appears to be more potential flexibility for monetary policy than has long been considered acceptable, then the proposals by Jeremy Corbyn in the UK’s Labor Party may be a sign that the tide is truly beginning to turn on the issue of monetary policy and roles of central banks.
Going even farther than Corbyn are efforts by others to advocate for central bank policies that are in line with governments’ commitments to various human rights treaties. But what do central banks have to do with human rights? In a primer written for RightingFinance, University of Massachusetts Professor James Heintz noted that the policies which central banks adopt can have important impacts on how well governments can realize the economic and social rights they have committed to in various international treaties and conventions. For example, according to Heintz, “If the central bank restricts the money supply and raises interest rates, this slows down the economy. A slower economy generates fewer jobs. Slower growth can reduce tax revenues that governments rely on for social and economic policies. Higher interest rates affect the sustainability of debt – both public and private – and may cause government to cut expenditures when interest payments on the debt rise.”
During an economic crisis, the actions of the central bank can also help stabilize the economy and prevent backsliding in the realization of rights more generally – as is often the case when governments adopt fiscal austerity. But the official mandates of most central banks are still excessively narrow, leading to conservative monetary policies and an inability to address extreme economic crises or promote other goals such as on employment and growth.
Heintz suggested that these narrow mandates could be changed in a way that includes a consideration of human rights, and Corbyn’s proposal to expand the number of tools in the central bank’s policy toolbox to pursue other socially beneficial goals, certainly moves the discussion in this direction – and does so in a way that has not been seen for several decades.
Rick Rowden is PhD Candidate in the Centre for Economic Studies and Planning at Jawaharlal Nehru University (JNU) in New Delhi.