The recent history of central banking has seen its increased influence in response to economic crises and reduced democratic oversight. Balance of Power by Éric Monnet illuminates how this shift came about and argues that democratic control must be restored. According to Ivan Radanović, the book is essential reading for understanding why reconnecting central banks to the people is crucial to meet the major challenges of our time, from rising inequality to the climate crisis.
The power of central banks has grown significantly in the last fifteen years, but the capacity of democracies to keep them under control has not. It’s time we rethink the consensus on their independence, which requires central banks to strictly adhere to their declared goals, independently from state influence. This was acceptable when central banking was relatively simple: declaring inflation corridors, conduct monetary operations and supervising banks. But times are not simple anymore, as shown from the economic crisis in 2008 to the more recent disruptions related to the war in Ukraine.
In his book, Éric Monnet argues that the policies of central banks are too important to be managed solely by independent authorities and technocrats, and should be endowed with real democratic oversight.
Financial stability is hard to define, which is a growing problem when increasing interventions are justified by this goal
How central banks grew stronger
Since the 1990s, the central banks of wealthy economies decreased the size and complexity of their interventions because they had abandoned their objectives of fixed exchange rates, which ended the need to buy and sell foreign exchange reserves. Also, it was accepted that central banks should have little influence on the markets. This was based on a belief in the virtues of markets as a driver of the financial liberalisation. The stability of the period fostered a belief that crises were a thing of the past.
That idea was cut short by the central banks’ reaction to the financial and economic crisis since 2008. Radical problems needed radical solutions. Even though the central banks described their policies as “nonconventional”, they – as Monnet writes – have become deeply conventional.
This transformation broke important taboos about historical practices of central banks. The first was a vast accumulation of public debt between 2008 and 2020. Just when some predicted that the global finances would return to the pre-2008 conditions, the European Central Bank (ECB) rolled out the “pandemic emergency purchase program,” which enabled it to acquire three-quarters of the total public debt issued by eurozone countries since early 2020 (65). This ran directly against the principle of independence which indicated they were not supposed to lend directly to governments. The second taboo was that of targeted lending. Central Banks were habitually granting long-term loans to banks, such as the ECB’s “long-term refinancing operations” (LTROs) or the newer “term funding schemes” of the Bank of England. But after 2008, they were afraid that banks would not use these secure loans to finance businesses. With “targeted long-term refinancing operations” (TLTROs), central banks were now packaging the credit with directions for the credit’s use.
The Machiavellian approach to debt
How did all of this happen? The author begins by outlining the basic functions of central banks. They are known since Adam Smith, who wrote that the Bank of England “acts not only like an ordinary bank but also like a great engine of the state.” Modern central banks have two main objectives: inflation targeting and maintaining financial stability. The second goal is more implicit and refers to the proper functioning of the credit system and a landscape composed of private financial institutions, the public treasury, public investment banks, and the central bank itself. Financial stability is not an explicit goal, because central banks are not the only institution with a duty to ensure financial stability – there are stock markets, regulators, the insurance sector, etc. Moreover, financial stability is hard to define, which is a growing problem when increasing interventions are justified by this goal.
The most paradoxical aspect of the central bank’s independence is that the interests and precise roles of their board members are impossible to characterise, let alone question.
The idea that end justifies the means is ascribed to Niccolò Machiavelli. However, in July 2012, another Italian announced a quite reminiscent policy. Mario Draghi, then chairing the ECB’s Board of Directors, announced that the ECB was “ready to do whatever it takes” to preserve the euro. These words led to the instrument called “outright monetary transactions” (OMTs), in which the ECB agreed to buy via the markets the public debt of a member country in crisis. But it was conditional: the country had to first call upon the European Stability Mechanism, the agency that would assess on what conditions a country could procure aid from the ECB. Due to a vague legal framework, these purchases were never implemented.
At that time, the ECB was part of the troika, which was also contested by the European Parliament. In the end, the ECB abandoned conditional instruments and instead turned to unconditional ones. In 2015, the ECB pursued a policy of “quantitative easing” (QE) – purchasing massive amounts of public debt. This was an existing practice in Japan, the US, and the UK.
In his analysis, Monnet turns to other vague central bank practices, such as bilateral loans, capital flow controls to regulate the movement of foreign capital, or developing central bank digital currencies. But who is authorised to take decisions with such massive financial, social, and geopolitical consequences?
How should central banks behave?
The most paradoxical aspect of the central bank’s independence is that the interests and precise roles of their board members are impossible to characterise, let alone question. This is the consequence of the philosophy that central banking is a purely technical task, insulated from democratic discussions. The influential German economist Rudiger Dornbusch used to say that “money is too serious to be left to politicians” – the same logic seems to be applied to the electorate.
Should the economic cycle be our farthest horizon when the biggest contributor to climate and social breakdown is economic growth itself?
In the fifth chapter, Monnet writes that central banks should stay independent from the executive powers of government, but not from the democracy. He follows Joseph Stiglitz, whose perspective is that central banking is not just technical; it involves trade-offs and judgments about emerging risks. This includes values. While Dornbusch sees delegation as the most important criterion, Stiglitz emphasises deliberation. Monnet rightly takes a position closer to the latter than the former. He calls for a better-organised deliberation and consideration of criticisms – a “reflexive legitimacy” (151-152). This would challenge the institutional imbalances between the ECB and European Parliament and enable action to combat the climate crisis, which can no longer be ignored. This could be approached from a perspective of financial stability because some assets now considered safe will become riskier with ongoing climate changes. Purchase of private assets from highly polluting enterprises should also be curbed, in line with the ECB’s legal objective of supporting the EU’s general policies (151-158).
Central banks and climate change
Beyond this, Monnet considers the future role of the ECB in financing the green transition, eg, through the green TLTROs. Green investments should be insulated from macroeconomic hurdles to preserve the environment and reduce our exposure to risks that may endanger the value of money or the credit system. The crucial thing is the coordination between fiscal and monetary policy so that they don’t induce opposing effects on the economic cycle.
But is that enough? Should the economic cycle be our farthest horizon when the biggest contributor to climate and social breakdown is economic growth itself? Monnet is right when he posits that central banks should “prepare themselves for a world in which consumption and GDP growth would no longer be the principal indicators” which would “make room for measures of environmental sustainability and well-being”.
There are plenty of environmental and well-being indicators already; the problem is that the economic growth imperative is just too seductive to allow us to substitute them for GDP. Even if we manage it, replacing GDP with a better indicator is like replacing the control panel in a car that is hurtling into the abyss.
Yes, we need central banks independent from political influence. And yes, they should act on the principle of deliberation, which we have heavily needed for more than a decade. Balance of Power is an essential read for illuminating why. But, above all, we need economies independent from the growth imperative. If democracy means anything, it means that we can agree to arrange things differently.
Note: This review gives the views of the author and not the position of the LSE Review of Books blog, nor of the London School of Economics and Political Science.
Image: Christine Lagarde creates the new signature on the 20 euro note in 2019 via European Central Bank on Flickr. License: CC BY-NC 2.0.
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