The problem is that asset prices and consumer-price inflation may move in different directions, as they did in the 2000s and that weighing both factors would produce inconsistent policy recommendations. As a result, central banks ran the risk of no longer appearing to follow a clearly formulated policy guideline. The credibility associated with a simple rule disappeared.
After the financial crisis, we have become wiser. Formulating monetary policy has become a more complex process, but also a more politicized process, which is why it is likely to become more chaotic, with sharp differences between national approaches. The Fed and the Bank of England remain less likely to be concerned about the emergence of new kinds of asset bubbles in stock markets or commodities. But the European Central Bank (ECB) will be more worried.
As divergences become explicit, the demand for a wider political debate about monetary policy and for political involvement in its formulation will become more intense. The Bank of England’s Monetary Policy Committee (MPC) has often been presented as a pioneer in making monetary policy transparent. But, from an early stage, the transparency that resulted from the early publication of who voted for and against rate increases led to a public identification of members of the Committee as hawks or doves.
If it is clear who will vote for which measure, there will be increased demand for a public debate about who should be chosen: Why not elect the MPC, since it is effectively a monetary government? In Europe, a similar debate about the political accountability of European central banks has been simmering since before the ECB was even established. Tensions between advocates of different policy solutions will lead to a demand for a greater political say.
This exercise looks like a dramatic repeat of the interwar story, when it was impossible to obtain consensus about policy and about mutually consistent policy frameworks. Then, too, central banks were blamed when their policy framework (at that time the gold standard) disintegrated. Consequently, nationalization of the central bank became a major platform of the British or French left.
That, in turn, cleared the way for manipulation of currencies in the interests of exporters, businesses and labor unions. The result was international monetary chaos — precisely the path we are heading down now.
Harold James is a professor of History and International Affairs at Princeton University and the Marie Curie Professor at the European University Institute, Florence.
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