MUNICH – Around the world, central banks’ balance sheets are becoming an increasingly serious concern – most notably for monetary policymakers themselves. When the Swiss National Bank (SNB) abandoned its exchange-rate peg last month, causing the franc to soar by a nosebleed-inducing 20%, it seemed to be acting out of fear that it would suffer balance-sheet losses if it kept purchasing euros and other foreign currencies.
Similarly, critics of the decision to embark on quantitative easing in the eurozone worry that the European Central Bank is dangerously exposed to losses on the southern eurozone members’ government bonds. This prompted the ECB Council to leave 80% of those bond purchases on the balance sheets of national central banks, where they will be the responsibility of national governments.
In the United States, meanwhile, the “Audit the Fed” movement is back. Motivated by growth in the Federal Reserve’s assets and liabilities, Republicans are introducing bills in both chambers of Congress to require the Fed to reveal more information about its monetary and financial operations.
But should central banks really worry so much about balance-sheet profits and losses? The answer, to put it bluntly, is no.
To be sure, central bankers, like other bankers, do not like losses. But central banks are not like other banks. They are not profit-oriented businesses. Rather, they are agencies for pursuing the public good. Their first responsibility is hitting their inflation target. Their second responsibility is to help close the output gap. Their third responsibility is to ensure financial stability. Balance-sheet considerations rank, at best, a distant fourth on the list of worthy monetary-policy goals.
Equally important, central banks have limited tools with which to pursue these objectives. It follows that a consideration that ranks only fourth in terms of priorities should not be allowed to dictate policy.
Indeed, a clear understanding of their priorities has often led central banks to incur losses when doing so is the price of avoiding deflation or preventing the exchange rate from becoming dangerously overvalued. The Chilean, Czech, and Israeli central banks, for example, have operated with negative net capital for extended periods without damaging their policies.
The reason why adverse consequences need not follow is that the central bank can simply ask the government to replenish its capital, much like when a government covers the losses of its national post office. Everyone is happier when transfers flow the other way. But the role of the central bank is not to be a profit center, especially when those profits come at the cost of other, more important policy objectives.
All of this makes it hard to fathom what the SNB was thinking. The sharp appreciation of the franc threatens to plunge the Swiss economy into deflation and recession. The risk of balance-sheet losses for the SNB, with its euro-heavy portfolio, may be greater now that the ECB has embarked on quantitative easing. But this is no justification for abandoning its mandate to pursue price and financial stability.
The SNB’s motive, it appears, was entirely political. Last year, the SNB was dragged into the highly charged debate surrounding a referendum on a “gold initiative” that would have required it to increase its gold reserves to 20%, and limited its ability to conduct monetary policy. One rationale for the initiative was to bullet-proof the SNB’s balance sheet against losses. This goal was especially dear to the cantons, the states of the Swiss Confederation, which rely on transfers from the SNB for a significant share of their budgets.
The “gold initiative” was voted down, but the political debate was traumatic. In January, with the accelerating depreciation of the euro, the debate flared up again. The fear was that the SNB’s balance-sheet losses might anger cantonal leaders to such a degree that the central bank’s independence would be threatened.
Whether true or not, the political salience of the issue underscores the dangers of an arrangement that precludes the SNB from focusing fully on economic and price stability. The obvious solution is not to abandon the franc’s euro peg, but to change the cantonal financing mechanism.
And, to those who are concerned for the SNB’s independence, one might ask a fundamental question: What is independence for if not to ignore those who complain that the central bank is insufficiently profit-oriented?
The same criticism applies to the loss-sharing arrangements that the ECB attached to its quantitative easing. The ECB’s priority should be to avoid deflation, not shield its shareholders from losses. The 80/20 loss-sharing arrangement with the national central banks may have made quantitative easing more palatable in Germany, but it casts doubt on the unity of the eurozone’s monetary policy. In a context in which the ECB is seeking to “do whatever it takes” to vanquish deflation, this is an unhelpful complication.
Central bankers are praised softly when they make profits and criticized loudly when they incur losses. They should have the good sense to ignore both the criticism and the praise. Particularly now, the world’s monetary policymakers have far more important problems to address.
Barry Eichengreen is Professor of Economics at the University of California, Berkeley; Pitt Professor of American History and Institutions at the University of Cambridge; and a former senior policy adviser at the International Monetary Fund. His newest book, Hall of Mirrors:The Great Depression, the Great Recession, and the Uses – and Misuses – of History, was just published by Oxford University Press.
Beatrice Weder di Mauro is Professor of Economics at the University of Mainz.