Is the practice of central banking credible?
What does this question imply for precious metals? In the economics world, there is no bigger, more loaded question. Are central bankers independent of the political process - i.e. do they have credibility beyond the political world?
To an outside observer, the answer would certainly be - no.
In the EU, a majority of the European Council appoints the head of the European Central Bank for an eight-year non-renewable term. The European Council comprises the heads of the state or heads of governments of EU member states.
In the US, the President appoints the head of the Federal Reserve for a four-year renewable term. The fact that central bank heads are appointed is evidence enough for many observers to argue that centralbanking is largely a political institution. In addition, central bankers and staff frequently meet with political leaders.
On the other end of the debate are individuals who argue that, although involved with political leaders and institutions, central bankers are free to set interest rate targets they control. They may also take actions related to influencing inflation and employment levels through the use of quantitative easing, regulation, and other policy tools. Central bankers can legally take these steps regardless of political leaders' desires.
As evidence, there are two figures presented here for the US Federal Reserve. (The ECB is much alike, although having been in existence for a much shorter period. (Due to the limited data for the ECB, the Federal Reserve was chosen as the illustration vehicle.)
The first chart shows how long (measured by days) and how quickly the loosening cycle took.
The second chart shows the same thing for tightening cycles.
Although central banks do many other things, these two charts represent the main, central policy tool available to central bankers.
The current loosening cycle is the longest on record. Should the Federal Reserve begin tightening in the first quarter of 2015, it will have been over 2,500 days since the US central bank first started relaxing short-term interest rates. In addition to the length of time of the current loosening cycle, the Fed has also kept the federal funds target rate lower, at peak, than any other time in history (see 2006 and 2007 of the tightening cycle).
The bottom line is this. Central bankers have, on a long-term basis - i.e. outside of cyclical trends! - reduced interest rates and lengthened the period over which interest rates stay low.
How does the empirical evidence connect with what politicians would want?
Here are four questions to see if central bankers are independent of political desires.
First, if you are a politician, you want money to be as cheap as possible. That has certainly been the trend over the past 70 years for tightening and loosening cycles.
Second, if you are a politician, you want interest rates to be non-volatile during both tightening and loosening cycles. That has happened.
Third, if you are a politician, during loosening cycles, you want cheap money to last a long time. Centralbankers, unsurprisingly, appear to have given in on this political desire as well.
Fourth, if you are a politician, you want tightening cycles to be short. Although tightening cycles have become much less meaningful in terms of depth (i.e. interest rate increases), tightening cycles have not become shorter.
Overall, three out of the four questions on politicians' desires show that political power is gaining strength over central bankers. The current loosening cycle - the longest on record - is a case in point.
