What can be more annoying than somebody pulling the emergency brake while speeding off with the pedal to the floor so fast that you can no longer support your head and need a headrest? What can be more frustrating than having your champagne coolers nicked while the music is blasting and everybody is on the dancing floor?
If our thinking is somewhere along these lines, then the lack of popularity of central banks with the general public and politicians is understandable. But given their key role in preventing major unbalances even by taking unpopular measures, the reason why central bank boards are not elected by popular vote stands to reason. This is why a clear separation between the political government and the central bank is paramount.
As the core business of any central bank is to keep inflation in check, once it increases too much all central banks have a mandate to take the required measures to contain price hikes. Firstly, by raising interest rates across the board and by reining in economic growth. All unpopular from a political standpoint. And yet, in most countries economically and politically mature, you will not hear politicians accusing the central bank of undermining the national economy or sabotage for attempting to bring inflation and growth to a sustainable level.
The US central bank, the Fed, has already entered a rising rates cycle. This could be stepped up in the coming months due to the procyclical tax policy of president Trump who decided to cut taxes while the American economy already showed signs of strong recovery. An overheated economy by tax policies? Does that sound familiar? And yet, nobody had the slightest intention of accusing the Fed of sabotaging economic growth by a rate increase. (at least for now …)
Such allegations tend rather to show up where there is a lack of understanding of how important a central bank`s independence from political decisions is. Somebody asked me the other day if I saw a threat of a self-induced crisis in Romania despite a stable international environment. A legitimate question because, in my opinion, if the 2008 world crisis hadn`t happened Romania might have been carried on with the massive current account deficit at the time. Because capital inflows would have continued for a while sustained by investors` exuberance. The moment that made everybody realize that “the emperor had no clothes” came with the crisis which stopped the capital flows financing our deficit.
As a result, I don`t think that there is an imminent danger in the current situation as long as the external environment remains favorable, despite the clearest negative internal tendencies: inflation goes up, foreign deficits go up as well, the currency devalues, and the economy “is roaring” far beyond its potential. These are circumstances where the NBR has to apply the brakes. This takes me to the main scenario which could cause possible economic deviations likely to throw the economy into a crisis in the absence of an external one: the NBR losing its independence and, implicitly, it’s ability to brake in time.
Let`s be clear. The NBR is not exactly spotless. I also, indicated the times when I considered that the reaction of the central bank was not appropriate. Regardless, however, we have to admit that in most cases in the past ten years the NBR was an island of stability, balance and professional despite a troubled, volatile political scene taking decisions more often than not emotionally or insufficiently substantiated. And that despite the fact that it has been singled out lately as a scapegoat, as the IMF has no longer been around to serve as one.
This is what we are seeing these days when “good or bad”, the NBR is no matter what a target of accusations. On the one hand, it is blamed for failing to keep the inflation under control, while being called to order for undermining the economy by rising rates. For those who would like to see the current growth rate maintained and low interest rates the Anglo-Saxons have a saying: have your cake and eat it. At the end of the day the NBR acts as the Fed does: increasing rates for fear of the inflationary pressures in a procyclical tax policy. Because this is their mandate.
It seems that politicians` actual concerns in terms of the monetary policy should be directed completely elsewhere.
Those nostalgic for the Ceausescu era have a very selective memory. They remember all the grand and megalomaniac investment projects conducted at that time and compare that with a lack of similar projects after 1990. The factories, bridges, canals, the House of the People and all others stand as undeniable proof of the then Supreme Leader`s vision. Truth is, though, much more subtle for those who actually want to see it.
Back then investments were divided into useless, meant only to satisfy the leader`s big ego, poorly substantiated that would never pay back the initial capital and economically viable projects, but mind you, viable in the foreign circumstances at the time (Comecon, etc.). The mind-numbing pace at which the two types of projects followed each other caused resources to be diverted from consumption to investments. Not to mention the defense budget by dispatching the military to do construction work.
Hence the paradox of having the population of a „developing” country getting poorer and poorer. The standard of living was in freefall. Money printed to pay wages was not reflected in consumer goods as they were neither manufactured, nor imported. The public did not consume the tons of steel, or chemicals produced per capita, nor did they make use of projects such as the House of the People. As a result, rebalancing demand and supply would have meant a price adjustment that would have dented Romanians` purchasing power. Therefore the demand would have collapsed to reach the anemic supply of goods and services. The prices set in office politricks had nothing to do with reality and fuelled the goods and services shortage.
The black market brought demand and supply in a state of equilibrium. Petrol station workers, waiters and cooks, slaughterhouse workers were in power.(It is not by accident that they are among the nostalgic) But these prices were no longer regulated. They were set ad-hoc and adjusted Romanians` purchasing power appropriately. Basically, the public supported the sensible or senseless projects by allowing their savings to lose value, and were thus able to buy less and less goods, dollars or German marks as the LEU was losing its real value.
Hearing about the NBR being the enemy of Romania`s growth brought back memories. The proponents of this theory consider that an increase in rates by the NBR is harmful because it pushes up lending and hence puts a damper on the financing of the economy. All the supporters of growth through low interest rate do is to replicate Ceausescu`s „development model” whereby the actual value of people`s savings was sacrificed on the altar of forced economic growth.
The longer the NBR maintains interest rates low for the sake of keeping the economy on the same track, as requested, the more inflation will eat away at the actual value of people`s savings. Let`s not forget that the key monetary policy rate is lower than inflation, and that commercial bank loan rates are therefore even lower. Under these circumstances, the NBR will have no choice but to raise the interest rate so as to uphold its mandate.
I would conclude with the joke made quite seriously by one of the Fed`s chairmen, William McChesney Martin: “The job of the Federal Reserve is to take away the punch bowl just as the party gets going.”
In Romania the party is in full swing. No wonder that the party boys want to shut the doors.
Have a nice weekend!
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