.

The European Central Bank (ECB) announced earlier this month that it was raising its overnight lending rate by a quarter of a percentage point to 1.25 percent. This is very bad news for people across the eurozone countries and possibly the rest of the world as well.

This action shows two things. First, the ECB is prepared to slow the eurozone economy and throw people out of work. This is the point of raising interest rates. The ECB targets two percent inflation with the current inflation rate in the eurozone around 2.5 percent.. The inflation rate is above the ECB target due to a jump in the price of oil and other commodities. These price rises in turn are primarily attributable to instability in the Middle East and increased demand from China, India and other fast-growing developing countries.

Raising interest rates in the eurozone will do little to reduce the prices of commodities. However if higher interest rates throw enough people out of work in the eurozone, it can place sufficient downward pressure on wages to offset the impact of higher commodity prices. If commodity prices rise by much more than two percent, then the ECB can make wages rise by less than two percent, thereby returning to its magic number and declaring 'mission accomplished'.

This brings up the other fact demonstrated by the ECB's action. It has learned nothing from the events of the last three years. Those who hoped that the worst economic downturn in 70 years might change the Bank's behavior are sure to be disappointed. It continues to adhere to its goal of maintaining an inflation target oblivious to the costs in unemployment and lost output.

Unfortunately, the ECB is not alone in this respect. Most central banks are now controlled by inflation targetters who explicitly ignore the impact of the banks' actions on output, employment and financial stability.

A deficit of democracy

The worst part of this story is that these fundamental decisions about economic policy are made by a small, secretive clique operating largely outside of the public's purview. Central bank decisions on interest rates are likely to have far more impact on jobs and growth than any of the policies that are debated endlessly be elected parliaments. Yet, these decisions are made largely without democratic input.

In fairness, politicians bear much of the blame for this situation. They established institutional structures that largely place central banks beyond democratic control. There is probably no bank that is as insulated from the democratic process as the ECB, in large part because of its multinational structure, but all the central banks in wealthy countries now enjoy an extraordinary degree of independence from elected governments. In many countries they are even more independent than the judicial system.

Even worse, the politicians have actually mandated many central banks, like the ECB, to pursue an inflation target to the exclusion of other considerations. This gives the central bankers a license to throw millions of people out of work in order to chase their obsession with inflation.

Giving the central bankers free rein to chase inflation targets could perhaps be justified if they had a track record of success, but they don't. The world economy stands to lose more than $10 trillion in output because of the central banks' failure to stem the growth of the dangerous housing bubbles.

While the central bankers were congratulating themselves for hitting their inflation targets, the bubbles were growing ever larger, and the financial system was becoming more highly leveraged. All they could express when the bubble finally collapsed in 2008 was their surprise.

In other professions, people would have been fired for such a momentous failure. However if any central banker lost their job due to this disaster, the firing was kept very quiet.

The economic crisis should have taught central banks that it is not sufficient to pursue an inflation target; maintaining high levels of employment and overall financial and economic stability are also important - and failure to meet these challenges should result in replacing the current crop of central bankers.

Processes must also be in place to hold the central bankers accountable to elected governments. The choices they make involve issues on which the public should have input, particularly the tradeoff between higher unemployment and the risk of more inflation.

Naturally, different actors will take different positions on this tradeoff. The financial firms, who tend to be close to the central bankers, are unlikely to be very concerned about the cost of unemployment. However, they will view the risk of higher inflation with enormous trepidation because it will typically lead to large losses for the industry.

The larger public is likely to take the opposite position, as moderately higher rates of inflation pose little cost. This choice should be the sort of topic that arises in political campaigns, since it is likely to have far more consequence for the public than whatever tax or spending policies the competing parties are promoting.

None of this means that we want politicians deciding interest rates. However, the people who do decide them should be answerable to politicians in a way that is not true today. In this way central banks should be like any other regulatory agency. For example, politicians do not decide which drugs the US Food and Drug Administration approves. However if it goes five years without approving any drugs - or approves a number of them that cause sickness and death - serious problems ensue.

In short, this is simply a question of restoring accountability to the central bankers for their management of the economy. The days of the central bank as a church beyond the reach of the commoners should be brought to an end.

Dr Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR) in Washington, DC. He is the author of False Profits: Recovering from the Bubble Economy. He also has a blog, "Beat the Press", where he discusses the media's coverage of economic issues. He holds his doctorate in economics from the University of Michigan.

This article was originally published at ISN Insights.  To view the original article click here

The views presented in this article are the author’s own and do not necessarily represent the views of any other organization.

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www.diplomaticourier.com

Tyranny of the Central Bankers

April 19, 2011

The European Central Bank (ECB) announced earlier this month that it was raising its overnight lending rate by a quarter of a percentage point to 1.25 percent. This is very bad news for people across the eurozone countries and possibly the rest of the world as well.

This action shows two things. First, the ECB is prepared to slow the eurozone economy and throw people out of work. This is the point of raising interest rates. The ECB targets two percent inflation with the current inflation rate in the eurozone around 2.5 percent.. The inflation rate is above the ECB target due to a jump in the price of oil and other commodities. These price rises in turn are primarily attributable to instability in the Middle East and increased demand from China, India and other fast-growing developing countries.

Raising interest rates in the eurozone will do little to reduce the prices of commodities. However if higher interest rates throw enough people out of work in the eurozone, it can place sufficient downward pressure on wages to offset the impact of higher commodity prices. If commodity prices rise by much more than two percent, then the ECB can make wages rise by less than two percent, thereby returning to its magic number and declaring 'mission accomplished'.

This brings up the other fact demonstrated by the ECB's action. It has learned nothing from the events of the last three years. Those who hoped that the worst economic downturn in 70 years might change the Bank's behavior are sure to be disappointed. It continues to adhere to its goal of maintaining an inflation target oblivious to the costs in unemployment and lost output.

Unfortunately, the ECB is not alone in this respect. Most central banks are now controlled by inflation targetters who explicitly ignore the impact of the banks' actions on output, employment and financial stability.

A deficit of democracy

The worst part of this story is that these fundamental decisions about economic policy are made by a small, secretive clique operating largely outside of the public's purview. Central bank decisions on interest rates are likely to have far more impact on jobs and growth than any of the policies that are debated endlessly be elected parliaments. Yet, these decisions are made largely without democratic input.

In fairness, politicians bear much of the blame for this situation. They established institutional structures that largely place central banks beyond democratic control. There is probably no bank that is as insulated from the democratic process as the ECB, in large part because of its multinational structure, but all the central banks in wealthy countries now enjoy an extraordinary degree of independence from elected governments. In many countries they are even more independent than the judicial system.

Even worse, the politicians have actually mandated many central banks, like the ECB, to pursue an inflation target to the exclusion of other considerations. This gives the central bankers a license to throw millions of people out of work in order to chase their obsession with inflation.

Giving the central bankers free rein to chase inflation targets could perhaps be justified if they had a track record of success, but they don't. The world economy stands to lose more than $10 trillion in output because of the central banks' failure to stem the growth of the dangerous housing bubbles.

While the central bankers were congratulating themselves for hitting their inflation targets, the bubbles were growing ever larger, and the financial system was becoming more highly leveraged. All they could express when the bubble finally collapsed in 2008 was their surprise.

In other professions, people would have been fired for such a momentous failure. However if any central banker lost their job due to this disaster, the firing was kept very quiet.

The economic crisis should have taught central banks that it is not sufficient to pursue an inflation target; maintaining high levels of employment and overall financial and economic stability are also important - and failure to meet these challenges should result in replacing the current crop of central bankers.

Processes must also be in place to hold the central bankers accountable to elected governments. The choices they make involve issues on which the public should have input, particularly the tradeoff between higher unemployment and the risk of more inflation.

Naturally, different actors will take different positions on this tradeoff. The financial firms, who tend to be close to the central bankers, are unlikely to be very concerned about the cost of unemployment. However, they will view the risk of higher inflation with enormous trepidation because it will typically lead to large losses for the industry.

The larger public is likely to take the opposite position, as moderately higher rates of inflation pose little cost. This choice should be the sort of topic that arises in political campaigns, since it is likely to have far more consequence for the public than whatever tax or spending policies the competing parties are promoting.

None of this means that we want politicians deciding interest rates. However, the people who do decide them should be answerable to politicians in a way that is not true today. In this way central banks should be like any other regulatory agency. For example, politicians do not decide which drugs the US Food and Drug Administration approves. However if it goes five years without approving any drugs - or approves a number of them that cause sickness and death - serious problems ensue.

In short, this is simply a question of restoring accountability to the central bankers for their management of the economy. The days of the central bank as a church beyond the reach of the commoners should be brought to an end.

Dr Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR) in Washington, DC. He is the author of False Profits: Recovering from the Bubble Economy. He also has a blog, "Beat the Press", where he discusses the media's coverage of economic issues. He holds his doctorate in economics from the University of Michigan.

This article was originally published at ISN Insights.  To view the original article click here

The views presented in this article are the author’s own and do not necessarily represent the views of any other organization.