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Satyajit Das: Trapped central banks and the semiotics of monetary policy


US Federal Reserve Chairman Ben Bernanke has introduced the term ‘taper’ to the lexicon of central banking. European Central Bank President Mario Draghi’s stated strategy is “whatever it takes”. Economic Commissioner Olli Rehn recently clarified that European policies were directed at ‘diluting’ not ‘breaking’ the link between banks and sovereigns.

Understanding monetary policy is now about semiotics instead of economics.

The surprise at the proposal is surprising. The Fed’s unprecedented monetary expansion was always temporary. Confirmation that the measures would not be wound back admits to failure of policies designed to create a self-sustaining economic and financial recovery.

The Fed Chairman also has to manage constituencies within the Federal Reserve uncomfortable with its expanded role and foreign nations concerned about the impact of US policies on their currencies and economies. Like ECB President Draghi facing an existential crisis of the Euro, Chairman Bernanke, in reality, had little choice.

The words, of course, may not translate into actions. The Fed has not halted purchases of Treasury bonds or increased interest rates. The ECB has not implemented purchases of government bonds. For the most part, they were vague, highly conditional statements of intention to take unspecified actions, in a yet to be formulated way at some future date based on a consideration of circumstances at the relevant times, possibly.

Despite the confusion about meaning, the statements had a significant impact on prices and rates, leading to large real changes in wealth. With bond and equity markets increasingly volatile, there are already suggestions that the Fed may delay tapering if worsening financial conditions hurt the economy.

The importance of central bankers and policy makers owes much to John Maynard Keynes and Milton Friedman, who in different ways advocated greater intervention. Former Fed Chairman Alan Greenspan’s success in stabilising financial market conditions in 1987 by announcing the Fed’s willingness “to serve as a source of liquidity to support the economic and financial system” was crucial. It paved the way for the ‘Greenspan Put’, giving practical credibility to central bank activism.

Provision of guidance to markets also became commonplace.  Alan Greenspan’s public appearances attracted financial analysts, journalists and linguists in equal numbers reflecting his ‘constructive ambiguity’. The Maestro provided guidance to interpreting his pronouncements: “If I have made myself clear then you have misunderstood me”.

The reliance on guidance and actual actions of policy makers is troubling.

It highlights the fragility of global economies and the financial system, now extremely reliant on government support. The need for guidance exposes the lack of potency of policy tools, which in some case may be approaching their limits of effectiveness or creating unintended side toxic effects, such as asset price bubbles. It creates uncertainty and volatility, undermining the policies themselves.

It illustrates the difficulty of international policy co-ordination. The Fed announcement coincided with a decision by the Chinese central bank to tighten liquidity, exacerbating the market reaction. Given different domestic agendas, the risk of individual action becoming destabilising is high.

It points to the excessive influence of Governments on markets. Successful investing now requires anticipation of official policy actions, rather than traditional analysis of fundamental factors. In this environment, price signals are misleading, distorting resource and capital allocation.

The process is undemocratic. Unelected officials, with limited accountability, can by their words or actions trigger large changes in prices and rates, affecting millions of citizens and businesses, both domestically and internationally. These policies can result in massive transfers in real wealth, redistributing employment, income, investments and savings between individuals in a country and between nations. It undermines crucial trust in institutions and policy makers.

Reliance on aggressive policies to resuscitate the global economy always risked ‘blowback’. Central banks could only buy time during which the necessary correction to the finances of governments, corporations, financial institutions and individuals needed to be done to restore economic health of nations.

Regrettably, the purchased time may have not been used productively, creating new dangers for the global economy without having dealt with existing problems. The required actions were also always likely to result in a sharp fall in economic activity exacerbating not solving the problem.

Policy makers are now trapped between existing policies of decreasing efficacy and increasing toxic side effects and withdrawing these measures with uncertain consequences, potentially a complete collapse.

Satyajit Das is a former banker and author of Extreme Money and Traders Guns & Money