The rate makers

Central bankers gained almost mythical status during and after the financial crisis. But where do they stand today?

Among its many repercussions, the financial crisis of 2008 had the effect of raising the status of central bankers to as-yet unparalleled heights. Faced with ailing economies, central bankers in the US, Japan, Europe and elsewhere went on acute alert, slashing interest rates and generally flexing their monetary muscle to avoid disaster. In the US, this involvement took on extreme proportions with the Federal Reserve’s quantitative easing (QE) measures — its strategy of creating cheap credit to stimulate the economy. As a 2014 article in Germany’s Der Spiegel pointed out, “To an extent unprecedented in postwar history, monetary watchdogs — who are not elected and are usually independent of their countries’ governments — determine what happens in politics and on the markets. They are the new ‘masters of the universe.’”

Of course, this wasn’t the first time central bankers had appeared on the public radar. During Alan Greenspan’s time as chairman of the Fed (1987-2006), he became a financial superstar: the slightest innuendoes and ambiguities in his statements were probed and scrutinized for any hint of what he planned to do. His predecessor, Paul Volcker (1979-’87), had also enjoyed his moment of fame, especially when he pushed the effective federal funds rate — the overnight rate at which depository banks lend to one another — up to 22% in the early 1980s.

But it was only after the crisis hit that central bankers reached such quasi-mythical status. For a while, it looked as though they could simply wave their wands and bend the economy to their will, especially in North America. Ben Bernanke, chairman of the Fed at the time, drew reams of press with QE, and Mark Carney, then governor of the Bank of Canada, gained a reputation as a charming fix-it man who was able to keep Canada safe from most of the mayhem south of the border.

But just as the aura surrounding central bankers was reaching its height, it was also starting to show signs of fading. As the article in Der Spiegel pointed out, even the bankers themselves weren’t buying the hype. And once Bernanke left his post and Carney moved on to the Bank of England, the position seemed to become less visible in North America. But that didn’t stop central banks in other countries from making unprecedented moves, mainly inspired by the US experience with QE. In 2013, the Bank of Japan caused quite a stir when it came out with a monetary stimulus plan that was considered even more radical than the Fed’s. And in 2015, European Central Bank president Mario Draghi made waves with a similar plan, even though it was slightly more conservative than Japan’s.

What exactly is going on with central bankers? How much influence do they really have?

There are no quick answers to these questions. First of all, while there are almost as many central banks as there are countries, only a handful hold centre stage. These include the US Fed, the European Central Bank, the Bank of Japan, and increasingly, the Bank of China. The Bank of England is still fairly influential, as is the Bank of Canada — in Canada. Still, the Bank for International Settlements has 60 members, which collectively represent 95% of the world’s GDP (see “Central Bankers’ Banks” below).


To understand what central banks do today and how much influence they actually wield, it’s useful to take a step back to 1694, when the Bank of England was created. The king at the time, William III, had such weak credit that he was unable to borrow the money his government needed to continue the war with France’s Louis XIV. So in exchange for an official charter that gave long-term banking privileges to the shareholders, he authorized the creation of a central bank. The new institution quickly financed the government to the tune of 1.2 million pounds, at an interest rate of 8%. Against the value of that debt, the Bank of England issued stock to the public.

To this day, the Bank of England still acts as the government’s banker, as do other central banks, including the Bank of Canada, which was created in 1934. But along the way, other roles have come and gone. For example, in the early 20th century, the Bank of England stopped acting as a commercial bank and no longer accepted deposits from citizens — a role that it had already begun to give up in the mid-1850s when large commercial banks started to emerge. Today, most central banks have one main priority: achieving price stability by maintaining inflation at a relatively low level. (The US is a notable exception in that it also has a mandate of maximizing employment.)

To fulfil their mandate, central banks operate at both macroeconomic and microeconomic levels. At a macroeconomic level, they use two key tools. First, they set a target interest rate on overnight loans that they make to private banks and that private banks and other participants in financial markets make between themselves. That rate is the base from which all other interest rates are derived.

Central banks also purchase bonds from their respective governments. In normal times, this ensures an orderly increase in the money supply. However, in the wake of the financial crisis, the US Fed stepped up its involvement in this area dramatically — or even “outrageously,” according to Richard Beaulieu, vice-president and chief economist at Addenda Capital in Montreal. After having slashed overnight interest rates to near-negative levels and finding this wasn’t enough to get the economy going again, the Fed decided in 2008 that it needed to do more to keep long-term interest rates low. So it implemented the first in what was to become three rounds of QE. This strategy consisted in purchasing massive amounts of bonds, to the tune of US$3 trillion to US$4 trillion, not only from government, but also from private banks and other sellers in the secondary market. The idea was to make a large amount of money available to banks so that they would then lend to corporations and homeowners. These loans would ultimately lead to productive investment, job creation and home purchases — economic growth, in other words.

Opinions differ as to whether this strategy was ultimately successful. Some likened it to pushing on a string: central banks tried to “push” banks into making loans by putting massive amounts of money at their disposal. But banks resisted the push and didn’t make the loans. (There were many reasons for this, according to Beaulieu. At the time, there were relatively few reliable borrowers to be found, and banks were rebuilding their capital base. So they kept the funds at the Fed, where they earned a more risk-free return than by lending to companies and consumers. It’s worth noting that consumers were also loan-shy at the time.)

At the moment, many central banks are starting to reverse their post-crisis measures. The Fed ended its last round of QE in late 2014 and, in December 2015, it started to push up its overnight rate, a measure that was repeated this spring. In Canada, rates were also expected to rise over the longer term. And while the Bank of Japan and the European Central Bank are still pursuing their own forms of QE, it’s still difficult to say how successful they have been: in Europe, modest signs of economic vitality are starting to appear, but the jury is still out on Japan.

At a microeconomic level, central banks play many roles. Among the most important is acting as lenders of last resort to individual banks in order to ensure their stability. During the crisis, this role of individual saviour morphed into one of collective saviour, since most of the major banks were in deep distress.

Central banks also ensure the integrity of the clearing and settlement systems for payment obligations between financial institutions, issue bank notes and act as fiscal agents for governments, especially in distributing their bonds. In a number of countries, including the US, but not Canada, central banks play important regulatory roles — by requiring banks to maintain certain levels of capital reserves, for example. One key role that central banks in advanced economies have relinquished since the 1990s is the stabilization of their currencies in international markets. Given that daily trading volumes in global currency markets have reached astronomical levels (US$5.1 trillion daily), those central banks are simply not big enough to play that role.


Central bankers were never meant to be masters of the universe — although following QE, they became much more influential in the financial world. David Longworth, former deputy governor of the Bank of Canada, now adjunct research professor at Carleton University in Ottawa, says he gives central banks “top marks” for restarting the financial markets after 2008.

Still, by allowing the Fed to implement the QE strategy while keeping interest rates at record lows, the US government also handed over to the Fed the job of priming the economic growth engine. And not everyone thinks it was up to the challenge. In his book The Courage to Act, Bernanke claims that he helped save the US economy from a catastrophe. But according to Beaulieu, although the economy was saved, bringing it back to health has been more difficult. The single most important consequence of the Fed’s massive measures, he says, “is that the prices of financial assets and real estate have exploded.”

Some also say we are now in a situation that could prove highly unstable. “Low interest rates for a short period of time are OK, but over a prolonged period, they really sacrifice our future economic growth,” says Andrey Pavlov, professor of finance at the Beedie School of Business at Simon Fraser University in Vancouver.

Today, many countries, notably the US and Canada, are trying to find paths to growth other than monetary policy. “It seems now more positive to have more active fiscal policies, increasing spending to increase output, and thus inflation,” Longworth says. But Beaulieu thinks caution is in order. Such actions could accelerate inflation and undo a fragile recovery. “Is it time for governments to start spending more and for central banks to increase rates? Are they right to excite a momentum that seems to be building up all by itself? Will public policies prolong the economic recovery or will they cut it short?”

All in all, it may be that central bankers’ mandates have indeed been overrated. “In recent years, and especially since the crisis, people started getting exaggerated expectations of what central banks can do,” says Alan Blinder, former vice-chairman of the board of governors of the Fed in Washington and an economics professor at Princeton University. “Their power is huge for determining short-term interest rates. I don’t think that’s diminished, but that’s about it. They can’t do anything about the tax system, antitrust regulation, education, productivity.”

William Scarth, professor emeritus of economics at McMaster University in Hamilton, puts it this way: “It’s ironic to consider central banks so powerful. When I talk to central bankers, they say that they are frustrated. [Stephen] Poloz [current governor of the Bank of Canada] still wants to give a sense of power, but it’s only as a show of confidence. Are they powerful? Normally, yes, but when interest rates are at zero they’re less so.”


Independence is a key issue for central banks. How close are the ties between governments and their central banks?

Most major central banks have been set up as autonomous bodies that are separate from the ministry of finance, but still owned by government. In the US, that independence appears to be well entrenched, since there is not a single government representative on the Fed’s board. Until 1936, the treasury secretary and the comptroller of the currency had been members, but they were excluded after that. “It’s hard to have an independent bank when the Secretary of the Treasury sits on the board,” says Blinder. In Canada, the deputy minister of finance sits on both the Bank of Canada’s board and steering committee, “without voting rights, but with veto rights,” says Montreal economist and author Bernard Élie. With such governance structures, central banks are meant to carry out the mandate given to them by governments, but without undue influence from vote-hungry politicians.

The Bank of China stands out as a major exception, since it appears to be mainly an instrument for carrying out government policies. “It’s the political leadership that leads monetary policy,” says Blinder. “The Bank of China is as much a development bank as a central bank, because it steers funds to preferred industries, regions and types of jobs, something western central banks hardly ever do.”

However, a question less often asked is, how independent are central banks from banks? In Canada, the separation is sharply drawn: private bank administrators, shareholders and employees are excluded from the central bank’s board. In the US, the situation is very different. None of the five board members at the Fed in Washington are bankers, but on the boards of the 12 regional reserves, three out of nine administrative seats are held by bankers.

To some, the Fed’s action in the wake of the financial crisis shows a lack of independence. “I do believe the Fed was mostly independent until 2008,” says Pavlov. “But the moment it started rescuing institutions on a massive scale and targeting a whole bunch of additional goals, above and beyond inflation, it became highly susceptible to both political and industry pressures. The Fed has even quoted the stock market run-up as evidence that [its] policies are working. I didn’t realize that stock market support is part of its mandate. Why is the Fed even remotely concerned with the stock market outcomes if it presumably has a narrow goal of controlling inflation?”

Some observers think that by making conditions easier for banks to lend money, central banks became too closely connected to the commercial banking industry. Andrew Huszar is one of them. As he explained in a November 2013 Wall Street Journal article, Huszar had been hired by the Fed to manage QE. But instead of “helping Main Street,” it was “the greatest backdoor Wall Street bailout of all time…. Despite the Fed’s rhetoric, my program wasn’t helping to make credit any more accessible for the average American. The banks were only issuing fewer and fewer loans. More insidiously, whatever credit they were extending wasn’t getting much cheaper. QE may have been driving down the wholesale cost for banks to make loans, but Wall Street was pocketing most of the extra cash.”

Today, some of those who don’t think the Fed’s attempts to stimulate the economy were successful have other ideas about what central banks could and should do. That includes reaching beyond commercial banks to make loans directly to consumers. In fact, a proposal along these lines has already been made. In an address to bankers in 2012, William Dudley, president of the Federal Reserve Bank of New York, “suggested $15 billion in bridge loans to tide over unemployed homeowners,” reports Randall Wray, a senior scholar at the Levy Economics Institute.

But Wray thinks the Fed could go even further. It could lend directly to industrial corporations and small businesses or it could steer banks to neglected categories of lending — small businesses, for instance — by lowering the reserve requirement on those loans. This wouldn’t even be a first, according to Wray. “The Fed made thousands of direct loans to private businesses during the New Deal,” he says. “Its industrial lending was eventually halted in the 1950s, but the practice appeared again in 1970.”


Alan Greenspan (The Oracle), chairman of the US Federal Reserve (1987-2006)

Alan GreenspanGreenspan was chairman for almost 19 years, the second-longest period in the history of the Fed, which was created in 1913. Although William Martin had the longest tenure — 1951 to 1970 — few remember Martin and many remember Greenspan. According to William Scarth, professor emeritus of economics at McMaster University in Hamilton, Greenspan’s visibility was linked to the fact that more people were participating in the stock market — and caring about it — than in previous periods. Greenspan, a believer in free markets and an avid reader of Ayn Rand (author of Atlas Shrugged, a bible for neoliberal thinkers), “led the fight to dismantle the New Deal, disabling the regulatory oversight designed to keep bank loans in line with the borrower’s ability to pay,” writes economist Michael Hudson in his book Killing the Host. But Greenspan’s belief in self-correcting markets was not rock solid if one is to believe a 2016 Wall Street Journal article that states that he “agonized about their instability long before the financial crisis.”

Ben Bernanke, chairman of the US Federal Reserve (2006-2014)

Ben BernankeA tenured economist at Princeton University, Bernanke was a specialist of the Great Depression. He was also a proponent of the “great moderation” theory, which holds that structural changes in the international economy have led to a decline in the volatility and instability of business cycles. Still, Bernanke had to deal with the financial crisis of 2008, and he did so by introducing a number of financial stratagems to bail out banks — including his strategy of quantitative easing, a massive purchase of bonds designed to reduce market interest rates. In his book The Courage to Act, Bernanke claims that by taking these measures he helped prevent an economic catastrophe worse than the Great Depression.

Mark Carney, governor of the Bank of Canada (2008-2013); governor of the Bank of England (2013- )

Mark CarneyIf there is one central banker who would qualify as a financial jet-set star, it would be Carney, who led the Bank of Canada during and after the crisis. He was also appointed chair of the Basel-based Financial Stability Board (see “Central bankers’ banks,” p. 38) in 2011, before moving on to head the Bank of England on July 1, 2013. As a 2014 article in Der Spiegel noted, “Carney is a new type of central banker — not some dry head of a government bureaucracy, but a cosmopolitan money manager who also happens to have created a new business segment, the transfer market for central bank heads.” And in a November 2016 article, The Toronto Star claimed that “Mark Carney might be the most important person in Britain post-Brexit.” Thanks in part to Carney, the Bank of Canada shone during and after the crisis because Canadian banks exhibited an uncanny resiliency compared with their peers elsewhere. But according to David Longworth, former deputy governor of the Bank of Canada from 2003 to 2010, the merit also lay with Canada’s Office of the Superintendant of Financial Institutions (OSFI): “Our banks were required to have more equity capital than most other jurisdictions and our supervision is principle-based rather than rule-based, as in the US or in Europe.” Instead of burying OSFI’s regulators under mountains of rules, principles allow them to keep a clearer view of their mandate.


The Bank for International Settlements (BIS)

The Basel-based BIS “is considered to be the “central bank of central banks,” says C.D. Howe Institute senior policy analyst Jeremy Kronick. Created in 1930, and formally owned by 60 of the world’s central banks, the BIS is meant to foster international monetary and financial cooperation and to act as an adviser to central banks. Though its counsel is not binding, the BIS carries a great deal of weight, as shown by the fact that most countries adopted its Basel III directives on regulation and risk management. These directives, which were issued in 2013, imposed higher capital reserve levels on banks than the two previous Basel accords had done, because the crisis had shown that those levels were insufficient. The BIS produces a large number of studies that often prove quite prophetic. “It was the one institution that saw the financial crisis coming, but nobody listened,” says William Scarth, professor emeritus of economics at Hamilton’s McMaster University.

The Financial Stability Board (FSB)

The FSB was created in 2009 by the G20 countries to promote the stability of the global financial system by making recommendations on regulation to its member countries and monitoring the implementation of those standards. Currently chaired by Mark Carney, former governor of the Bank of Canada and now governor of the Bank of England, it serves mainly as a forum where the world’s highest-ranking monetary officials can discuss issues such as fintech regulation, trade and problems specific to individual countries. On occasion, the board publishes reports on these or other issues. Every G20 country (plus a few other banking centres) has two or three officials from its finance ministry and central bank on the FSB plenary — its decision-making body. The FSB is a successor to the Financial Stability Forum, which was created in 1999 by the G7 countries and had a similar mandate. However, the financial crisis of 2008 showed that it was not a resounding success.