The succession of crisis which have hurt the Western Countries for fifteen years with successively the sub-primes, the risk of explosion of the euro zone, the Covid-19 pandemic and at last the invasion of Ukraine by Russia has, each time, put the central banks at the heart of the measures devised by the governments to soften their economic consequences. Even when their status was explicitly or not guaranteeing their independence and their freedom of action and when their mandates were fixing the price stability as their main objective, their policies had to be in keeping with a context of international cooperation and of consistency with the decisions taken by the public powers and their objectives in a much larger field.
So they deviated from the role the economic theory had attributed to them in the Sixties, especially thanks to their capacity to slow demand through the reduction of the monetary mass growth through interest rates increases. That allowed to fighting against the unbalances provoked by a too strong demand to be satisfied by production apparels. The most spectacular case, and which is still the benchmark today, was, after his nomination at the head of the Federal Reserve in Washington, the Paul Volcker action from the end of 1979, who brutally increased rates which then overpassed 15%, which was going to send the American economy into recession two years later.
The independence status has an historical origin. Germany didn’t want never again know the Twenties hyperinflation and it was necessary to protect against the risks of a too complacent government whose action could again lead to such excesses. This risk has not disappeared in the world and we still have observed, especially in Latin America and in South-East Asia until the Nineties, major monetary crisis. The strengthening of the power of the central bank and its independence was so the sine qua non condition of the acceptation by Germany of the creation of the euro and France had accepted that principle.
Two factors have disrupted the rules of the game and have progressively leaded, without that was inscribed in the status, to enlarge the central banks field of action and especially their intervention modes. There was first the globalization and the capital flows liberalization. The action of a country, in the monetary field, through its central bank, had immediate consequences on the currencies and so on financial markets. The first crash on international markets occurred in December 1987 when the Federal Reserve and the Bundesbank, without giving the sentiment they consulted each other, took decisions which were misinterpreted.
The second factor, and by far the most important one, is the accumulation of wealth in the world which have been invested in the financial markets. The monetary policies have now immediate repercussions and much more important on assets than on the production and the exchanges of goods and services. The monetary theory which had granted this role to the central banks, is for a long time obsolete. Now, their mission, by far above prices stability, is extended, without being explicitly included in their mandates, to the financial markets stability. The first example has been their action during the sub-prime crisis. The global recession which followed it and the necessary reduction of the risks weighting on the banking systems have leaded the central banks to support the putting into practice of accommodative policies and the adoption of new prudential rules.
A little after, the excessive public indebtedness of several countries, and especially Greece, has leaded the chairman of the European Central Bank, Mario Draghi, to announce he will do “whatever it takes” to protect the euro. To achieve this objective, he facilitated the financing conditions of the debts and the survival of the banking systems of the concerned countries, and notably the Irish one. The default of one of these countries would have affected the credibility of the common currency. These decisions constituted an essential precedent which opened the way to the ECB and to its president to act now in favor of the solvability of the State-members and of the financial stability of the euro zone. During the entire period which followed, the inflation issue was not anymore actual because that one had near disappeared in Europe, but also in the other developed countries.
A new period for the central banks was opened with the sanitary crisis. In order to softening its economic consequences, the affected States increased, in unprecedent proportions, public expenditures to provide a support to enterprises and to household, to limit the number of failures and to slow the unemployment increase. That generated a massive increase of public deficits. Then, the central banks with at the first position the ECB, facilitated their financing through purchasing programs of public debts on the financial markets, without, at any time, that the inflationist consequences were put forward, and notably in Germany, which even made its constitutional rules more flexible. During that period, short and long-term interest rates were even negative, which has allowed in France to the State, when its indebtedness was rising rapidly, to have a yearly reduction of its debt charge. Despite different political and legal contexts, the same action was observed in most of developed countries.
The invasion of Ukraine with its consequences on fossil energies prices and the rebound of the pandemic in China with its bottlenecks on the supply chains put an end to that long period without inflation and we look at its sharp comeback which reminds us the end of the Seventies. But the central banks, despite their mandates provisions are far from having adopted the “Volcker method” and from having launch restrictive policies able to stop the inflation comeback. In the United States, the Fed rates increases are without any link with the prices evolution. In Europe, the monetary support process has progressively reached its end and only a symbolic increase of the basic rates is envisioned. At the same time, an action is forecast to protect the consistency of the euro zone and to avoid that the spreads between countries increase on the financial markets.
So, in order to avoid to send the world into a deep recession and in the current dangerous geopolitical context, the central banks have made the choice to be in keeping with the economic policies decided by the governments and having as a destination to limit as much as possible the consequences of the sanitary and geopolitical crisis on activity. That choice has also been dictated by the taking into conscience of the repercussions of their decisions on the financial markets. The risk couldn’t be taken to add to the current crisis a major financial one.
The world has changed also for the central banks. The price stability target is not any more their main reason of being. They cannot, as during the Volcker period, act independently from each other. The consequences of their decisions on the financial markets and on the currencies markets must be taken into consideration and prudence stands out. At last, the monetary policy inscribes itself in the whole economic policy of the concerned governments and the central banks cannot ignore it. So, their relations with the political authorities which have been democratically elected must be close. So they must, them also, adapt themselves at that new era.