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Home > Blogs > Anthony Harrington > A wake-up call to the US Federal Reserve from Caruana – Part 2

A wake-up call to the US Federal Reserve from Caruana – Part 2

Central banking | A wake-up call to the US Federal Reserve from Caruana – Part 2 Anthony Harrington

In a speech delivered at the South African Reserve Bank on 1 July 2011, Jaime Caruana, the general manager of the Bank of International Settlements gave central bankers a series of pointers about what not to do after a financial crisis. Two of his key points were: (1) Don’t keep rates too low for too long (if you do you are simply engineering the next boom and bust cycle) and (2) don’t look just at the impact of what you are doing on your own economy, look at the “collateral” damage you could be inflicting. The last point is particularly interesting because it is only true, by definition, of economies with sufficient scale to create damage outside their own borders – think US and China here, with possibly the eurozone as a block as the third target of his speech.

In this second part of my blog series we look at Caruana’s comments on the relationship between central bank policies and global commodity prices. He points out that commodity prices inevitably play a very important role in shaping central-bank thinking. In today’s world central banks around the globe all work off the idea that inflation targeting is one of their prime missions, and probably the prime mission. Without price stability economies run wild, resources are misallocated, value is destroyed. So they target inflation and try to keep it within whatever band seems optimum, usually between 2% and 3%, with rapidly-growing economies tolerating a bit more inflation and slow-growth mature economies generally disliking anything above 2% inflation. Rising global commodity prices feed into the CPI and play havoc with central bank calculations. So they are a factor.

However, as the Federal Reserve Chairman Ben Bernanke noted in a recent speech, rising commodity prices are not exactly within the control of central bankers. They can’t do much about the onward march of the price of oil, for example – apart from engineering a major bust in their own economies, which would certainly flatten demand and impact the oil price that way, but in that instance, the cure would be far worse than the disease, so it’s not exactly an option. Similarly with rising agri-commodity prices. If Nature smites the grain growing regions of the world with a combination of floods and droughts, the resulting shortages drive up the price of grain, which pushes up meat prices and inflation starts to roar.

In the face of these obvious “externalities” Caruana points out, central banks have a habit of adopting a very passive posture. As he puts it:

“It is quite common for countries to treat commodity price increases as “imported” and hence independent of their policies. This may be so from the perspective of an individual economy. But it cannot be true globally. Commodity prices are very sensitive to global demand conditions. In turn, these conditions are naturally shaped by central banks’ collective decisions, that is, global monetary conditions. In an uneven recovery, this raises a number of policy challenges.”

This is a hugely intriguing point. We’ve already cited Bernanke’s point about the difficulty of central bankers influencing, say, the price of oil. Caruana comes at this from a slightly different angle though. What he suggests is that, while individually central bankers might not have a tool in their tool box that enables them to reach out and tweak, say, the price of corn or oil, collectively what they do does impact global demand, which, in turn, impacts commodity prices.

I really do not know quite what Caruana is saying here, and I suspect, neither does he. Quite clearly, as a responsible central banker, he is not calling for a cabal of central bankers to control world commodity prices. So some kind of explicit collective action by the world’s central banks is not on the cards. What he does go on to suggest, however, is that the lesson in all this for central bankers is that they need to “shift to a more global analytical approach towards monetary policy, one that seeks to factor in interactions and feedback effects”.

"Such a shift would resemble the move that has already occurred in regulation and supervision, from a micro- to a macroprudential perspective. A frank exchange of views on the international dimension of domestic policies is a first step towards better domestic policymaking."

At this point his attention seems to switch back to his other theme, namely that central banks need to consider the wider impact of the policies they adopt, which pulls him off in the direction of the US Federal Reserve engendering currency wars by devaluing the US dollar through QE. It is a fair point, but it leaves one wondering quite what he actually wants, and what this “more global analytical approach” would look like in reality, if it were to come to pass.

The problem is that central bankers like stability and markets like freedom of movement. Inside every central banker, it seems, there lurks a central planner whose ultimate goal is the ordered world of the bee-hive… It’s not their fault. It goes with the job. But oh my, they do need watching…

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Tags: Bank of International Settlements , Ben Bernanke , BIS , Caruana , central bank policies , central banker , central bankers , central banking , central banks , commodity prices , economic governance , Federal Reserve Chairman , financial crisis , financial policy , global commodity prices , global economy , global financial crisis , global monetary policy , global recession , inflation targeting , inflation targetting , interest rates , Jaime Caruana , monetary policy , US commodities , US economy , US Fed , US Federal Reserve
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