Editorial. There’s been a creeping erosion of central bank authority globally

What’s the biggest but seemingly unsolvable economic problem facing the world today? Like icebergs in the ocean, it’s central banks. Here’s why. Contrary to the myth propagated by the English that they set up the world’s first central bank, it actually came into existence in Sweden in 1669. But it is also true that the English merchants of the City of London defined its traditional function of lending to the sovereign and, if he or she was unable to repay the debt, printing money to pay themselves. That was in 1694 and it was only in 1946 that the Bank of England was nationalised. The Reserve Bank of India (RBI) too had private shareholders and was nationalised in 1949.

Since their inception central banks have evolved very considerably. But their two basic responsibilities assumed in 1694 remain the same. Sadly, since 1971 when the world went off the gold standard, they have been consistently falling down on the job, especially now since 2008. They have neither been able to control sovereign borrowing nor, therefore, control the supply of money. They were supposed to be the controlling authorities but, instead, are very much the controlled authorities now. In fact, they are not even like what the greatest governor of the Bank of England, Montagu Norman, had said the RBI should be like — a “Hindoo wife” who advises the husband, namely, the government, but doesn’t insist beyond a point. But now even that advisory role stands greatly diminished. Central banks, the world over, have become what the late finance minister of India, TT Krishnamachari said in 1958 of the RBI: that it was a “subordinate department” of the finance ministry.

It is a long and sad story of creeping erosion of the power of the central banks to say no to governments when they want to borrow in what they think is the public interest. It is the direct consequence of acknowledging sovereign power as being absolute in fiscal matters. That wasn’t so until recently. It’s a new doctrine governing central bank behaviour that makes central banks accomplices in bad fiscal policies. But there are no rewards because the onus of controlling inflation from loose fiscal policies has now been placed on the central banks. But when they raise interest rates — which is all that they can do anyway — the blame for the resulting contraction in economic activity is also placed at their door. It’s a case of heads I win, tails you lose. Talk about whipping boys.

That’s not all. Sovereign borrowing might be the gorilla in the room but there are the bond markets, too, the new masters. Central banks worry about them like a mother worries about a wayward child, always ready to please it. The result has been an increase in waywardness, not a diminution. The more financially open an economy is, the less control the central banks have. This has been formalised as the Taylor Rule to justify weakened central banks who now have an excuse to be derelict in their duty.

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