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PORTSIDE CULTURE

BALANCE OF POWER: CENTRAL BANKS AND THE FATE OF DEMOCRACIES  
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Ivan Radanović
November 7, 2024
LSE Review of Books
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_ Reviewer Radanović calls this book essential reading for
understanding why reconnecting central banks to the people is crucial
to meet the major challenges of our time, from rising inequality to
the climate crisis. _

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_Balance of Power
Central Banks and the Fate of Democracies_
Éric Monnet
Translated by Steven Rendall
The University of Chicago Press
ISBN: 9780226834139

The power of central banks has grown significantly in the last fifteen
years, but the capacity of democracies to keep them under control has
not. It’s time we rethink the consensus on their independence, which
requires central banks to strictly adhere to their declared goals,
independently from state influence. This was acceptable when central
banking was relatively simple: declaring inflation corridors, conduct
monetary operations and supervising banks. But times are not simple
anymore, as shown from the economic crisis in 2008 to the more recent
disruptions related to the war in Ukraine. 

In his book, Éric Monnet argues that the policies of central banks
are too important to be managed solely by independent authorities and
technocrats, and should be endowed with real democratic oversight.

Financial stability is hard to define, which is a growing problem when
increasing interventions are justified by this goal

HOW CENTRAL BANKS GREW STRONGER

Since the 1990s, the central banks of wealthy economies decreased the
size and complexity of their interventions because they had abandoned
their objectives of fixed exchange rates, which ended the need to buy
and sell foreign exchange reserves. Also, it was accepted that central
banks should have little influence on the markets. This was based on a
belief in the virtues of markets as a driver of the financial
liberalisation. The stability of the period fostered a belief
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that crises were a thing of the past. 

That idea was cut short by the central banks’ reaction to the
financial and economic crisis since 2008. Radical problems needed
radical solutions. Even though the central banks described their
policies as “nonconventional”, they – as Monnet writes – have
become deeply conventional. 

This transformation broke important taboos about historical practices
of central banks. The first was a vast accumulation of public debt
between 2008 and 2020. Just when some predicted that the global
finances would return to the pre-2008 conditions, the European Central
Bank (ECB) rolled out the “pandemic emergency purchase program,”
which enabled it to acquire three-quarters of the total public debt
issued by eurozone countries since early 2020 (65). This ran directly
against the principle of independence which indicated they were not
supposed to lend directly to governments. The second taboo was that of
targeted lending. Central Banks were habitually  granting long-term
loans to banks, such as the ECB’s “long-term refinancing
operations” (LTROs
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“term funding schemes
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of the Bank of England. But after 2008, they were afraid that banks
would not use these secure loans to finance businesses. With
“targeted long-term refinancing operations” (TLTROs), central
banks were now packaging the credit with directions for the credit’s
use. 

THE MACHIAVELLIAN APPROACH TO DEBT

How did all of this happen? The author begins by outlining the basic
functions of central banks. They are known since Adam Smith, who wrote
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of England “acts not only like an ordinary bank but also like a
great engine of the state.” Modern central banks have two main
objectives: inflation targeting and maintaining financial stability.
The second goal is more implicit and refers to the proper functioning
of the credit system and a landscape composed of private financial
institutions, the public treasury, public investment banks, and the
central bank itself. Financial stability is not an explicit goal,
because central banks are not the only institution with a duty to
ensure financial stability – there are stock markets, regulators,
the insurance sector, etc. Moreover, financial stability is hard to
define, which is a growing problem when increasing interventions are
justified by this goal.

The most paradoxical aspect of the central bank’s independence is
that the interests and precise roles of their board members are
impossible to characterise, let alone question.

The idea that end justifies the means is ascribed to Niccolò
Machiavelli. However, in July 2012, another Italian announced a quite
reminiscent policy. Mario Draghi, then chairing the ECB’s Board of
Directors, announced that the ECB was “ready to do whatever it takes
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to preserve the euro. These words led to the instrument called
“outright monetary transactions” (OMTs), in which the ECB agreed
to buy via the markets the public debt of a member country in crisis.
But it was conditional: the country had to first call upon the
European Stability Mechanism [[link removed]], the agency
that would assess on what conditions a country could procure aid from
the ECB. Due to a vague legal framework, these purchases were never
implemented. 

At that time, the ECB was part of the troika, which was also contested
by the European Parliament
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In the end, the ECB abandoned conditional instruments and instead
turned to unconditional ones. In 2015, the ECB pursued a policy of
“quantitative easing” (QE) – purchasing massive amounts of
public debt. This was an existing practice in Japan, the US, and the
UK. 

In his analysis, Monnet turns to other vague central bank practices,
such as bilateral loans, capital flow controls to regulate the
movement of foreign capital, or developing central bank digital
currencies. But who is authorised to take decisions with such massive
financial, social, and geopolitical consequences?

HOW SHOULD CENTRAL BANKS BEHAVE?

The most paradoxical aspect of the central bank’s independence is
that the interests and precise roles of their board members are
impossible to characterise, let alone question. This is the
consequence of the philosophy that central banking is a purely
technical task, insulated from democratic discussions. The influential
German economist Rudiger Dornbusch used to say that “money is too
serious to be left to politicians” – the same logic seems to be
applied to the electorate.

Should the economic cycle be our farthest horizon when the biggest
contributor to climate and social breakdown is economic growth itself?

In the fifth chapter, Monnet writes that central banks should stay
independent from the executive powers of government, but not from the
democracy. He follows Joseph Stiglitz, whose perspective
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banking is not just technical; it involves trade-offs and judgments
about emerging risks. This includes values. While Dornbusch sees
delegation as the most important criterion, Stiglitz emphasises
deliberation_._ Monnet rightly takes a position closer to the latter
than the former. He calls for a better-organised deliberation and
consideration of criticisms – a “reflexive legitimacy”
(151-152). This would challenge the institutional imbalances between
the ECB and European Parliament and enable action to combat the
climate crisis, which can no longer be ignored. This could be
approached from a perspective of financial stability because some
assets now considered safe will become riskier with ongoing climate
changes. Purchase of private assets from highly polluting enterprises
should also be curbed, in line with the ECB’s legal objective of
supporting the EU’s general policies (151-158). 

CENTRAL BANKS AND CLIMATE CHANGE

Beyond this, Monnet considers the future role of the ECB in financing
the green transition, eg, through the green TLTROs. Green investments
should be insulated from macroeconomic hurdles to preserve the
environment and reduce our exposure to risks that may endanger the
value of money or the credit system. The crucial thing is the
coordination between fiscal and monetary policy so that they don’t
induce opposing effects on the economic cycle. 

But is that enough? Should the economic cycle be our farthest horizon
when the biggest contributor to climate and social breakdown is
economic growth itself? Monnet is right when he posits that central
banks should “prepare themselves for a world in which consumption
and GDP growth would no longer be the principal indicators” which
would “make room for measures of environmental sustainability and
well-being”. 

There are plenty of environmental and well-being indicators already;
the problem is that the economic growth imperative is just too
seductive to allow us to substitute them for GDP. Even if we manage
it, replacing GDP with a better indicator is like replacing the
control panel in a car that is hurtling into the abyss. 

Yes, we need central banks independent from political influence. And
yes, they should act on the principle of deliberation, which we have
heavily needed for more than a decade. _Balance of Power _is an
essential read for illuminating why. But, above all, we need
economies independent from the growth imperative. If democracy means
anything, it means that we can agree to arrange things differently. 

_NOTE: This review gives the views of the author and not the position
of the LSE Review of Books blog, nor of the London School of Economics
and Political Science._

Ivan Radanović is an economist at the National bank of Serbia and
economic journalist based in Belgrade. He received an MSc in Universal
basic income at Faculty of Economics at the University of Belgrade.
His research covers history of economic thought, comparative economic
systems and theory of degrowth. He has written for Nova ekonomija,
Politika, NIN and other publications and portals in Serbia. Tweets
@IvanRadanovic_ 

* history of banking
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* central banks
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* economic management
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* public regulation
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