Unpredictable Central Banks: shape of things to come?

Monetary policy decisions are now emerging as another risk parameter into our decision matrices.

For the last several months, Indian industry had been pleading for an interest rate cut to help the economy. The Government of India and the Ministry of Finance, too, gave enough indications of their strong preference–that the Central Bank should consider slashing interest rates to egg growth along. But, to no avail.

The Reserve Bank Governor, Raghuram Rajan, in his characteristic – polite, seemingly accommodating, but unrelenting style – stood firm. He maintained that the signals in the economy needed to trend positive – consistently – before the Central Bank responded. Not much changed between his last policy statement in late November and the sudden announcement on 14th January reducing the interest rate by 25 basis points. Of course, we aren’t complaining because it was what we were hoping for. But till the cut became public, there was little to suggest that it was on the cards. It was almost like the intention was to surprise.

Cut to the scene of the Swiss Central Bank. Three years ago, it fixed a floor for the Swiss franc. The stated and overt monetary policy policy objective was to not let the Swiss Franc appreciate beyond a point – essentially to protect Swiss exporters – known for their high-quality, high-value products. Life was chugging along, and suddenly last week – the same time as India’s rate cut – the Swiss Central Bank turned its policy on its head. The Swiss franc soared against the euro by a dizzying 30 per cent. No prior warning, just like that.

While there isn’t enough information available, yet, on who will suffer or perish – for example commercial banks that have provided currency hedges and of course, exporters – it would be fair to expect bloodshed in the ecosystem.

And maybe that’s fair. It isn’t the job of central bankers to keep businesses safe. If they announced their policies beforehand, the theory of rational expectations would suggest that they wouldn’t be able to achieve their objectives. It is just that central banks over the years have behaved sedately and predictably. If they want to alter behaviour now, to achieve greater impact with their policy instruments, then we must recognise that and build it into our expectations.

An article written by Clive Crook, the Bloomberg View columnist argues that Central Banks have only two jobs – keep inflation low and keep politics out of monetary policy decisions. However, with recessionary pressures and problems of unemployment, how bereft can Central Banks remain of politics and the realities surrounding them?

The US Fed, over the years, had managed to extract a high degree of autonomy for itself, but their economic and social context has managed to weaken the resolve. At such times, is it going to be possible to keep politics out of Central Bank decisions?

The next one on the radar is the European Central Bank and its verdict around Quantitative Easing. As we go to print, speculation is rife around the announcement and its scale. The implications for the Euro and every other related currency will be watched closely – and here too, there is an element of the unknown.

Analysts, bankers and CFOs expect to be surprised by politicians, competitors and markets. But Central Bankers? Not yet. Is it time to introduce one more risk parameter into our decision matrices, or is this just an aberration?

I, personally, think it is more fundamental than a blip, but what do you think?


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