A change in central banking?

As central banks buy stocks and bonds in order to prop up the economy, Bryane Michael FRSA, asks whether this will be effective and whether the Covid-19 crisis could cause a much needed change in central banking?

Central banks around the world have started buying private companies’ stocks and bonds again. The European Central Bank (ECB) Pandemic Emergency Purchase Programme will pump €750 billion into private sector bonds (and other investments). The US Federal Reserve will go so far as to buy ‘junk bonds.’ All this despite highly unpredictable results and questionable legal authority.

In our recent research, we have looked at the effects of central bank purchases of stocks and bonds.  We found that during the last crisis, these purchases helped a few countries such as Panama and Burkina Faso. But the evidence for places like Europe and the US remain far more uncertain. Worse still, such purchases could actual stunt growth, in a way we call a ‘sloth effect.’ Easy money carries predictable consequences and support from banks like the ECB could exacerbate existing problems with existing government spending, rather than make them better.

Yet, for many countries such purchases could solve all kinds of problems. Corruption and inefficiency makes typical government spending leaky. Their central banks actually provide a better chance at getting money out the door than the government. As shown in our study's the figure, some of these governments include Bulgaria and Greece. Greece particularly serves as an interesting example.  Greece has relatively ‘porous’ government institutions (prone to corruption). Yet, its own central bank – an affiliate in the Eurosystem – has relatively strong institutions. The Greek central bank could thus, probably, get the money out the door much more reliably than the Hellenic Republic’s national or sub-national governments. Yet, for that, Greece would need a new central bank law.

Worse still, we find that most countries’ laws do not even really allow for these purchases, at least in principle. We find that both the US and EU relies on a very flimsy legal basis for these purchases. In the US, Article 13 of the Federal Reserve Act contains only a tangential mention of these purchases and many noted legal scholars argue that these purchase remain illegal, under existing rules. The EU faced similar pressures at home from legal scholars there.

In our own study of central banks worldwide, we find that less than 25% have anything resembling an authorisation to buy the private sector’s stocks and bonds. Places like Malaysia and the Philippines have central bank laws that outright forbid any kind of central bank support of private companies’ stocks and bonds. No country has a central bank law explicitly and positively authorising such purchases as an objective of central bank action. Without these statutory authorisations, regulators cannot do their job of making the rulebooks and regulatory guidance that enables their citizens and electorate to discuss how (and why) these purchases should be conducted. 

The Covid-19 crisis represents a good opportunity to review these central bank laws. With interest rates near zero percent worldwide, central banks can hardly keep buying government bonds. More and more ‘unconventional monetary policy’ will involve the purchase of private firms’ stocks and bonds. Yet, no parliament has debated the merits and demerits of these purchases. Few probably even understand them. Yet, parliamentary debate of reforms to central bank laws that would allow for these unconventional monetary policies, would make central banking far more legitimate and able to secure the support of the public.

Maybe central bank law should keep up with the times?

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Bryane Michael, FRSA, works at the University of Hong Kong's Faculty of Law and advises on various EU and UN projects. His background includes teaching economics and management at the University of Oxford, working at the World Bank and OECD. He speaks English, French, Spanish, Russian, Turkish and 500 characters of Mandarin.