With Ben Bernanke getting 1/3 of this year’s Nobel, a few reminders: No central bank has ever managed to keep inflation low, stable and predictable, not recently, not in the late 1970s, early 1980s, not before, during and after the 2008 crises, and not in recent years. Neither do they know anything about the consequences of their own actions – as Fed chairmen and presidents of central banks have admitted repeatedly, Bernanke included.
On September 21, Jerome Powell said that "We don’t know — no one knows — whether this process [rate hikes] will lead to a recession or, if so, how significant that recession would be." In 2015 Tim Geithner, president of the New York Fed and later Secretary of Treasury, on a panel with Robert Rubin and Hank Paulson, two previous Secretaries of the U.S. Treasury, said: “We certainly don’t know anything about how economies perform in the short term and even over the long run.” On January 10, 2008, Fed Chairman Bernanke stated: “The Federal Reserve is not currently forecasting a recession.” In June 2008, he added, “The risk that the economy has entered a substantial downturn appears to have diminished over the past month or so.”
Janet Yellen, Bernanke’s follower at the Fed, and now Secretary of the Treasury declared in January 2007: “My own view is that under appropriate monetary policy the economy is still likely to achieve a relatively smooth adjustment path, with real GDP growth gradually returning to its roughly 2½ percent trend over the next year, and the unemployment rate rising very gradually to just above its 4¾ percent sustainable level.” When leaving the Fed in 2010, she admitted: “I did not see and did not appreciate what the risks were with securitization, the credit ratings agencies, the shadow banking system, the S.I.V.’s. I didn’t see any of that coming.” Phillip Lowe, Australia’s central banker, stated in 2022, that since 2020, the bank’s performance and forecasts that interest rates would not rise until 2024 were “embarrassing” errors.
In light of this, what should be the mandate of central banks? What was the once Bernanke-celebrated-celebrated QE about?
Yes, central banks did play critical roles during major emergencies and wars – during WWII and until 1951 in particular - but the Federal Reserve was then an agency of the Treasury whose mandate was to prevent default of U.S. government bonds (which is roughly what Bernanke did, though without admitting). Other times central bankers, as seen above, were as good achieving their goals as Communist Russia’s 5-year planners, even when their mandate was only to keep inflation and unemployment rates low and stable. Their failures notwithstanding, governments have recently expanded central banks’ mandates to allocate capital to specific sectors and take into account inequality too, even though this means that they play explicit fiscal roles with claims of “independence” ringing hollow. Such expansion of their mandate may now stop as the Fed, the ECB, the Australian and Swiss, the Canadian central banks, naming a few, have significant operating losses and massive losses on their balance sheets (if their balance sheet was marked-to-market); the losses bringing unexpected burdens on taxpayers, hidden from sight until now.
Anticipating losses, a Fed release on January 6, 2011, titled: "Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks," announced changing its accounting - burying losses in an accounting gimmick. In an op-ed (Forbes, January 11, 2011) I wrote that the change meant that when the Federal Reserve incurs both operating losses and losses on its balance sheets – having bought bonds at low rates and facing later higher rates - the central bank will not have to record either. Instead, the Fed will debits them to a liability account called "Interest on Federal Reserve Notes Due to the U.S. Treasury": As long as operating losses last, they would not transfer a penny to the Treasury. The accounting fiction ensured that the Federal Reserve Bank complied with the statutory mandate of the Federal Reserve Act.
The Fed transferred to the Treasury between 2012 and 2021 roughly $1 trillion. However, the government must now take into account diminished remittances for years to come and either increase taxes or lower spending. This must happen as the Fed bought roughly 5 trillion of fixed return financial instruments at high prices that now, with the higher interest rates, imply losses that by some estimates run in the $300-$500 billion range. Another 2-3 trillion on the Fed’s balance sheet is currency in circulation up from half a trillion in 2008.
Briefly, taxpayers bear the cost of this monetary experiment. In contrast to the Fed, Isabel Schnabel on the ECB board stated this sharply: ‘In raising policy rates … central banks would be willingly accepting losses on their balance sheets that would ultimately lead to losses for the average taxpayer… This could lead to negative Bundesbank equity … [and] undermine confidence in the capacity of the German Bundesbank. The same holds true for the European Central Bank, whose rule is that the losses can be compensated for with funds from the general reserve fund and from monetary income… However, there is no provision on compensating losses that exceed those funds.”
This brings us to the issue of central banks’ mandates. As long as: The Fed prints money, which is, legally speaking, the government’s non-interest paying perpetual bond; People are eager to hold it; And the Fed buys interest earning Treasury bills - great. The Fed remits the difference to the Treasury and the Congressional Budget Office considers it in its budget provisions.
But in both 2008 and during the Covid panic, not only the Fed, with Bernanke at the helm, but all central banks ventured into a monetary experiment not much different from what the Fed did during and after WWII, and until 1951, , buying not only T-bills with minuscule, if any, interest, but a wide range of higher-yielding bonds too, though the higher yields implied greater risk of losses, of default in particular - as ECB acknowledges, referring to Italian, Greek and Spanish government bonds.
This monetary experiment (called “QE”) appeared to work for a while, even giving rise to academic speculations that even if trillions of money were printed – there is no harm. The Fed exchanges “helicopter money” that cost nothing and it never redeems it, for financial instruments that disappear in a puff. Where is the loss? Indeed, as long as people held on to the increased liquidity (with drastically lowered velocity), it appeared that there were free lunches in this world after all.
However, don’t confuse brains with bull markets in bonds and currencies. As the present events around the world make it clear, taxpayers of the countries whose central banks engaged in this monetary experiment are now paying for the losses in the shape of higher taxes, higher inflation, more regulations (that are often less visible forms of taxation) when mandating the allocation of capital in particular.
Which brings up the main issue: What central bank mandate can prevent such monetary experiments that throw on taxpayers unexpected burdens? Paul Volcker got it right when he insisted that floating exchange rates were a main culprit, getting societies in mazes of confusion. Having the mandate of stabilizing these rates and getting governments to impose on central banks the execution of such narrow mandate was the long-lasting solution for both domestic and international financial stability.
