Outlook: Central banks: an endangered species?
Saturday 28 August 1999
At the beginning of the decade, there were only three large countries - the US, Germany and Switzerland - that had genuinely independent central banks. Today they are too numerous to list, including our own Old Lady of Threadneedle Street. It has become a prerequisite for fully paid up membership of the global economy to have one, and the active pursuit through them of price stability has become one of the great economic mantras of the age.
But will it for ever be thus? This was the subject of a characteristically penetrating analysis yesterday by Mervyn King, deputy governor the Bank of England, to a symposium sponsored by the Federal Reserve Bank of Kansas City at Jackson Hole, Wyoming.
Central bankers find themselves in a position of power and authority unrivalled in their history, so much so that it seems more than possible the impending millennium will come to be seen as the high water mark of their influence. In future there may be less of them, and perhaps, Mr King tantalisingly suggests, they may face extinction altogether.
There are essentially three reasons for thinking this. The first concerns the possibility that central banks screw up - that through over- vigilant pursuit of price stability they plunge the world into recession or worse. In such circumstances, as Japan has already discovered to its cost, the central bank becomes impotent to act. Since nominal interest rates cannot fall below zero, monetary policy becomes powerless in the face of falling prices and the central banker loses his purpose.
It is this possibility, already a reality in Japan, that makes our own "symmetrical" inflation target, where it is as much a sin for the Bank to undershoot as to overshoot, such an important innovation.
Perhaps a more tangible threat to the central bank's growth stock status is exchange rate volatility. Liberalisation of capital flows and the often violent exchange rate fluctuations which has gone with it has made governments a lot less keen on national currencies than they were. More regional monetary unions seem certain, or failing this, the creation of currency boards or even complete currency substitution, as mooted by Argentina at the height of last year's currency turmoil. Either way, there is less of a need for national central banks.
But according to Mr King, the most potent threat comes from technology. This is where we begin to enter the world of science fiction, for although the Internet's impact on all aspects of the economy has already been profound, the real turbo charged effect is yet to come. One possibility is that the world will move towards a "pure exchange economy", in essence a world without money in the accepted sense. The primary purpose of a central bank is to act as a clearing house for transactions in the national, or in the case of Europe, regional currency. Plainly that purpose would be removed in the event of a moneyless economy.
In Mr King's vision of the future, individuals engaged in a transaction would settle by a transfer of wealth from one electronic account to another in real time, without any recourse to a central bank.
Financial assets and real goods and services would be priced in terms of a unit of account that would be calculated by reference to pre-agreed "algorithms". It is easy to see how globalisation and the growth of e- commerce makes this all too possible. Already the net allows for a degree of international price transparency that threatens to undermine the pricing mechanisms of many smaller national currencies.
That central banks are made an endangered species by these processes is perhaps the least worrying thing about them for national policy makers. For them, much more concerning is what technology might do to the tax system. Just as the net is no respecter of boundaries in terms of where goods, services and information are bought and sold, nor does it care a fig about where they are taxed.
The gaming industry's flight to offshore tax havens such as Gibraltar may be only a harbinger of things to come. It is only a matter of time before music, videos, software and perhaps a myriad of other services too come "tax free" through the net, downloaded from the British Virgin Islands or wherever the tax is least. The net might thus eventually allow ordinary people too to join the rich and the multinationals in escaping the tax system altogether, at least for a part of their income and spending.
In the meantime, Mr King doesn't perhaps need to worry too much about his long term employment. There would have to be regulatory organisations to monitor, arbitrate and licence these new "wealth banks" even in the moneyless, pure market economy he envisages. In the UK, banking supervision has already been stripped away from the Bank of England and placed with the Financial Services Authority but this won't stop the Bank trying to grab it back if there is nothing else to keep it gainfully employed. One way or another, there will always be a job for central bankers.
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