Why the first foreigner in 318 years to run the Bank of England is a good choice

November 28, 2012
November 28, 2012

The news that Mark Carney, governor of the Bank of Canada, will succeed Mervyn King next year as head of the Bank of England was  a surprise—not for any lack of credentials on Carney’s part, but because he’ll be a foreigner in a sensitive job he’d said he didn’t want. Still, the question of qualifications is interesting. What does it take these days to be a good central banker?

Here’s a tentative list: Be right, be persuasive and be strong—and if you can’t manage all of that, be lucky.

Being right is harder than it used to be. Once, central banking was mainly about monetary policy, and in ordinary times that wasn’t too hard. The policy rule first proposed by Stanford University economics professor John Taylor (initially as a description of what the US Federal Reserve actually did, rather than what it ought to do) posited a simple formula: on one side, short-term interest rates, the Fed’s main policy lever; on the other, inflation together with a simple measure of slack in the economy. When inflation is too high or the economy is above “full employment”, interest rates should go up. The Taylor rule is a way to put monetary policy on auto-pilot. Nothing to it.

But monetary policy gets complicated if inflation is close to zero and there is a lot of slack in the economy. In that case, the Taylor rule calls for negative interest rates, as it has in many countries at various points in recent years. You can’t have negative interest rates, so achieving the necessary degree of monetary stimulus then requires unorthodox measures such as quantitative easing. That’s difficult both technically (because it’s uncharted terrain) and politically (because it arouses fears of unchecked inflation and is controversial).

The Great Recession didn’t just make monetary policy more challenging, it also added to the demands that governments have put on central banks. The main new idea is macro-prudential supervision. Financial stability, on this view, requires oversight of macro-financial quantities such as leverage. If loan-to-value ratios in the housing market, for instance, rise to dangerously high levels, some kind of regulator ought to take notice and act—and it’s natural to assign this job to the central bank. And if the central bank is controlling short-term interest rates and keeping an eye on macro-financial ratios, it also seems plausible to give it the primary role in the traditional micro-regulation of individual banks.

The resulting three-part assignment of monetary policy, macro-prudential oversight and micro-regulation of financial institutions constitutes a big expansion of the central banker’s duties. This is the job—newly defined, duly enlarged, and significantly bigger than the role he had at the Bank of Canada—that awaits Carney in Threadneedle Street.

His credentials, insofar as credentials matter, are impeccable. Ben Bernanke at the Fed and Mervyn King at the Bank of England were top-notch macroeconomic scholars, reflecting the earlier primacy of monetary policy. Carney is not of that breed. He’s smart, all right, with an Oxford DPhil in economics, but he wasn’t an academic. He worked for Goldman Sachs before moving to Canada’s civil service and then to its central bank.

He’s widely seen as having done a fine job there. Canada’s prospects aren’t cloudless—there’s suspicion of a housing bubble—but the economy escaped the recession with little damage. And Carney’s achieved eminence in global financial circles as chairman of the Financial Stability Board, a new international coordinator of financial regulation.

In a crisis, though, credentials don’t count. On paper, Carney looks a better prospect than, say, Paul Volcker did in 1979 when he took control of the Fed. Nonetheless Volcker achieved his unsurpassed stature as a central banker by being right, by being seen to be right (after the fact), and by never flinching in his determination to crush inflation in the early 1980s. Volcker was strong when strength was what mattered.

Bernanke’s and King’s legacies are more complicated—partly because both men are implicated in the errors that caused the crisis, and even more because the verdicts on their remedies aren’t in yet. To see the hazards of jumping to conclusions, you need only think of Bernanke’s predecessor, Alan Greenspan. Not startlingly qualified for the job, in office he was revered for shrewd judgment, then subsequently reviled for his inattention to the impending disaster. The judgment on Bernanke and King could still go either way—though fair-minded observers give both high marks to date.

Carney hasn’t been tested like Bernanke or King—something that will change next year, since Britain’s prospects aren’t rosy. Carney himself says he’s going where the challenge is greatest.

On toughness, time will tell, but his judgment looks good. He’s a pragmatist rather than a hardliner of any particular school. At a time when central banking has no choice but to develop new competencies, that’s welcome. He also arrives with plenty of political capital, since the British government went to great and public lengths (paywall) to close the deal—agreeing to a shorter term (five years not eight) and a much fatter salary (by Bank of England standards) than it intended. The appointment has been widely praised. All this strengthens his hand.

A main challenge will be explaining himself to the public—an increasingly important task for central bankers, since unconventional methods oblige them to stray into areas close to fiscal policy, which is intrinsically political. Canada hasn’t stretched him in this respect as much as Britain will. It won’t help that he’s a foreigner, or that the British press specializes in puffing people up before tearing them to pieces. But again Carney shows signs of being shrewd.

Canada’s Globe and Mail proposed an interview at a sushi bar: too pretentious, said Carney, suggesting a burger place instead. The “common touch”, the paper called it in a gushing profile, before moving on to his intellect, charisma and persuasive powers. The Brits will like all that. For a while anyway.

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