Can Central Banks Deliver Us from Evil?

Article excerpt

The Prime Minister was talking to an obviously receptive audience yesterday when he said: "Inflation is like a hard drug: you may feel better for a while, but in time its evil effects become apparent." He was speaking at the Bank of England tercentenary symposium at the Barbican in the City - and if you are addressing more than 100 central bankers, it is hard to say you are against sound money.

The theme of the symposium was set by the initial paper* on the way central banking has developed over the years. At one level this is a thorough account of the way in which central banking, as an industry, has grown over three centuries, and the way in which three areas of tension keep recurring: between commercial banks and the central bank; over whether monetary policy should be set by rules or discretion; and between central banks and governments.

There are fascinating parallels here between the state of central banking now and in the 1840s, for in both these periods governments have looked to central banks to re- establish financial discipline after an unsettled period. In the first case this was in the aftermath of the Napoleonic Wars; in the second, the great inflation of the 1970s and 1980s.

But the paper is not just an account of past successes and failures, for it carries a powerful and explicit warning. Viewed from a long historical perspective, central banks have been particularly unsuccessful during the last 30 years in maintaining price stability. We have just lived through the worst peace-time inflation for at least 300 years. It is as a result of this failure that central banks are being given greater independence.

But suppose central banks now fail to deliver price stability? There is a danger that the benefits of independence have been oversold, but the threat goes deeper. The very fact that they are being accorded a greater role in the workings of the modern state transfers much of the pressure that had previously been placed on politicians to central bankers. If inflation continues, there will be no one else to blame. "Central banks", the report concludes, "cannot afford to be complacent. There is much to learn and much room for improvement."

There are really two possible responses to the question of what happens if the central banks do not deliver. One is discussed by Charles Goodhart and his colleagues here, and one we can see day-to-day in the financial markets.

The first is what is called "free banking". …