If you’ve made it this far, I assume you elected to be an audience. Part 1 looked at the risible idea that ‘biodiversity and loss of nature will be top of the financial sector’s agenda in 2024’. And look! The link shows the original claim that biodiversity will be top of the agenda has vanished. Gee! Odd to make such a grand claim and then instantly discredit that claim by its removal.
Be that as it may, similar claims for central banks to consider social issues have been a problem for years. It is time for a review and a clear out. In effect, since the Global Financial Crisis all central banks adopted a role as arms of the welfare state, and in the case of the ECB as sole (unelected) guardian of the entire project. The problem is not that such responsibilities lack importance. The problem is the lack of precision, measurement, capacity and appropriate framework within central banks. If something needs to be fixed in society, legislation through elected bodies is the proper avenue, not bribery via central bank policy.
Inclusion of issues, such as ‘biodiversity’, into central bank strategy looks not only inappropriate. It looks uncomfortably close to an inducement to corruption. The inclusion of nebulous ambitions suggests an attempt to expand patronage and support. Sadly, this may be an attractive inducement for central bankers, having lost the confidence of their natural constituents through policy failure. The inclusion of ‘biodiversity’ considerations, though, is likely further to dilute the primary objectives of a central bank and so further damage both the reputation of the institution and the well-being of those who depend on the currency it administers.
How so? Well, first let’s look at what central banks have got wrong and consider a proper course of action to put past errors right. Then let’s consider why central banks appear so averse to reform. Finally, we’ll illustrate how deep this rot has become.
The glaring errors
Central banks are under considerable and justifiable scrutiny. They don’t like it. The main duty of these public bodies is to protect the integrity of their currency. That duty has been undermined on two fronts by all major central banks over a number of years. First they failed, spectacularly, to maintain price stability. Indeed, they are plausibly charged with actively promoting inflation from 2020 till early 2022. Second, as a consequence of these policy choices, financial instability across the West has become a perennial systematic spectre rather than an occasional exigency.
The message of the following chart is that the Fed has consistently missed its price stability mandate on the upside, while the ECB has missed on both the upside and the downside. Which is worse? They are as bad as each other.
Financial stability used to be an important, but rarely referenced aspect of central bank responsibility. The expansion of central bank balance sheets and the accompanying growth in financial influence via assets and liabilities means uncertainty about the entire system has increased, not diminished. No decision can now be made without some consideration of what unwelcome outcome may follow. This is not helped by regulatory imperatives to concentrate financial power in fewer hands with ever greater reliance on the hierarchy of a dollar system. For instance, the effect of moving to an entirely collateralised financial system globally is to emphasise the centrality of the Federal Reserve and the US Treasury market. A perturbation at the top can create serious disturbance lower down – look at UK’s LDI episode in 2022.
Neither of these two institution failures (inflation & financial stability) need be a permanent embarrassment. To correct such organisational failure an institution needs to consider how the deviancy occurred and what needs be done to reduce future mistakes. Any reasonable solution would include identifying core objectives and re-establishing their primacy to the exclusion of distractions. It would also require avoiding any further ad hoc additions to existing financial architecture. Naturally, this would require a degree of humility and, by extension, curtailment of policy experimentation – such as flirtations with ‘biodiversity’.
What is actually happening?
To date the response of central banks to failure has been disappointing and self-serving. Yes, there are pro-forma acknowledgement of remorse by individuals and even institutions. But it is pretty weak stuff.
For example, Jerome Powell said at the September 2023 press conference that “forecasts are highly uncertain. Forecasting is very difficult. Forecasters are a humble lot with much to be humble about.” Notice the comment permits continuity of failed processes, as much as, or even more than, reflection and change. It seems a kind of shrug – ‘we do our best, even if it’s never very good.’
Institutions have made some attempt to persuade the public they will address failings. There was an announcement by the Bank of England of a review of forecasting. Sadly, the evasive nature of the project is suggested by the fact is is led by Dr Ben Bernanke, a central banker whose credentials for judging forecast accuracy is distinctly patchy, notwithstanding his Nobel award. Bestowing the leadership of a review to a colleague whose own mistakes are probably a source of shame seems a sure sign of institutional insecurity.
The ECB’s Lagarde has said “What we should have learned is that we cannot just rely only on textbook cases and pure models. We have to think with a broader horizon.” Well, a broader horizon is exactly the wrong solution. Better to concentrate on a limited horizon with which you should be familiar.
Why do central banks find reform so difficult?
Central bankers suffer from a troublesome institutional ambiguity as guardians of economic stability. Is admission of ignorance dangerous? The impression they frequently give is ‘we’d prefer to dissemble than to admit how uncertain we are!’ Honest improvement would require them to admit their knowledge is circumscribed and contingent.
Instead, the solution all central banks have adopted is to dress their ignorance in faux probability estimates and always, of course, provide a ‘baseline’ forecast. This gives the impression of precision yet permits plausible leeway, ex-poste, for error. This approach protects them from charges of dereliction of duty while simultaneously avoids proper consideration of real uncertainty. It seems close to deceit, a ‘get out of jail free’ card.
This approach is understandable. For if central banks are open about the true variance of outcomes they fear societal confidence will evaporate. It is understandable, but not forgivable. It is the main part of a central banker’s job to craft and to promote a response to radical uncertainty, not to avoid it.
All investors, successful or unsuccessful, grapple with the limits of knowledge, and if they wish to persist in investing they have to accommodate their tendency to fallibility. If they wish to maintain a public following, they have to promote their limits as well as their skills.
Any system of dynamic uncertainty such as a portfolio or a currency system must commit to dealing with unknown, though possibly bounded, degrees of confidence. That is not hard to convey to the public. It does, however, require a perennial commitment to ‘learning’ based on Popperian notions of contingent knowledge.
How deep is the rot?
Regrettably, central banks now seem to seek consolation from criticism and meaningful reflection through flirting with the devil of public (and publicised) virtue. Such as mulling the importance of biodiversity for central bank strategy. Apart from anything else, the framing of the issue implies the inclusion of such strategy is of indisputable merit. If so, then expect a lot of mud to be thrown at the cart. But how far does this rotten attitude extend?
The gradual and long-running extension of overt social welfare into central bank policy may mean the malaise is deep. From 2008-2012 central bankers evidently decided that policy should include protection of companies, countries and individuals from insolvency. Initially, this policy was a response to panicky estimation of the risks of depression. Fair enough. But the emergency was never declared over. Instead, ever-wider social advocacy was appended, presumably to create something ‘useful’ when money was free. And there is a never-ending list of protections the public require. Where to stop?
Now money is no longer free, in part because of past errors of central banks. The protections we previously thought so affordable should have become out-of-reach baubles. The discount rate that determines the value of our future has risen. But rather than restrict the ambitions, higher rates mean those who wish us to finance those baubles are forced to raise ever higher and more ludicrous demands for sacrifice. Hence the claim that biodiversity will be the top item of the agenda for finance in 2024. Whoever thought that claim could be taken seriously?
Let’s be clear, no central bank has reliably calculated R* for an economy despite several centuries of attempts and despite the supposed importance of such a measure for the welfare of the population. Estimating R* is relatively simple compared to the assessment of ‘nature-based dependencies’.
Where did this stuff come from? There is form. Mark Carney is on record as supporting the Taskforce on Climate-related Financial Disclosures (TCFD), which also has the very public support of Michael Bloomberg – and the UN and lots of other worthies.
Acute readers will notice the suspiciously similar name to the ridiculous Taskforce for Nature-related Financial Disclosures (TNFD) which prompted the first of these posts. As of October 2023, the TCFD (the Carney/Bloomberg gig) decided its job is done as ‘climate related reporting requirements and standards’ have been incorporated into the SEC, UK Parliament, European Commission and International Sustainability Standards Board (which informs additions to the International Financial Reporting Standards).
If legislators wish to impose constraints on their citizens the legislature is the proper place to do so. In this case, the legislative burden was largely outsourced to the SEC and the European Commission. Neither is a surprise. Complex financial regulation has been used to bamboozle legislators into accepting ill-advised reform for decades.
Notice the TCFD has nothing whatsoever to do with central bank policy. Nor should it. Nor should the TNFD – apologies for the acronym fatigue. And notice also how the TNFD is explicitly modelled on the TCFD, including all its main objectives and nebulous metrics, and even its website design. Here is a prime example of the ‘cut’n’paste’ social engineering now deemed to be within the orbit of central bank policy. Not just the climate, but all the monkeys in the world must now be considered. Once the grift has been proven to extract rent, it can be reused for further grift.
But here the Bundesbank finally appears. For it is the Bundesbank who have decided to endorse distraction of central banks at the 27th January event hosted by OMFIF. Who would have thought this possible? Who could have predicted that the global bastion of monetary and financial stability could have decided to endorse an egregious undermining of the primary objectives of central banking?
Of course, the Bundesbank representative may appear precisely to counter the claims of other participants. The Bundesbank’s representative may simply be there to say: ‘No, never, go away you ridiculous charlatans. Responsible central bankers will have nothing to do with you’.
But that doesn’t seem a plausible role for someone who describes themselves on LinkedIn as the ‘Green Finance Expert at the Deutsche Bundesbank’. I admire the assumption of capital letters in the title – it may just be misguided German language influence but it sure lends an aura of bogus authority.
We have to start somewhere in stopping this rot. I have decided that inclusion of biodiversity as ‘the top item of the finance agenda for 2024’ and its insertion into central bank strategy is where my line is drawn. On reflection, however, the line is arbitrary and once you decide reform is necessary it opens the way for a thorough cleansing of the Augean stables. Who knows, if we unwind all the ad hoc policy errors, one day central banks may even care about the money they oversee. And yes, there is a deliberate reference to the environmental damage required to clean the stables of Augeas and to the ensuing conflict the cleaning caused.