Webinar Summary – Unexpected Revolutionaries: How Central Banks Made and Unmade Economic Orthodoxy

By Manuel Cruz

On Thursday, March 21, the Boston University Global Development Policy Center hosted Manuela Moschella, Professor of Political Science at the University of Bologna, to present the main ideas of her forthcoming book, “Unexpected Revolutionaries: How Central Banks Made and Unmade Economic Orthodoxy.” In her discussion, Moschella explained the institutional transformation of central banks from the 1970s to the present. The event was moderated by Perry Mehrling, Professor of International Political Economy at the Boston University Pardee School of Global Studies.

Moschella’s book opens by noting that, while the role of central banks has been transforming over time, their role particularly shifted after the 2008 global financial crisis and the COVID-19 pandemic. Traditionally, central banks were seen as focused on controlling inflation through interest rate adjustments. However, their actions post-crises went beyond this narrow mandate by applying unconventional economic policies. They have intervened in financial stability, pursued inclusive growth objectives and even addressed social issues like climate change. These actions have blurred the lines between central banks and fiscal authorities, challenging their long-held image.

She argued that central banks worldwide have adopted unconventional policy levers to address issues beyond the limited mandate of price stability. Despite maintaining formal independence from electoral politics, she demonstrated that central banks are responsive to public interests and depend on political backing for legitimacy. Moschella emphasized the role of central banks in allowing liberalism to thrive when she evaluated the history of central banks. In the neoliberal economic order, independent central banks, armed with the power to influence interest rates as the primary monetary policy tool, have become the lynchpin of the financial system. Nonetheless, it has been observed that central banks have expanded their toolkit to address goals other than inflation during times of economic hardship.

The prevailing explanation for this transformation has generally focused on technocracy. This theory suggested that central banks, having learned from past mistakes, adopted new ideas about quantitative easing and financial stability. Their independence supposedly empowered them to act decisively. Moschella, however, noted that she finds this view lacking and proposes an alternative perspective. Although central banks are undoubtedly technocratic and independent, they also operate within a domestic political context. In other words, their success hinges on a certain degree of public support. They must navigate various audiences – financial markets, governments and citizens – as their legitimacy and credibility depend on them. As Moschella pointed out, central banks need to maintain public trust in addition to merely satisfying the expectations of the financial markets. As part of her explanation, Moschella also mentioned former Chair of the Federal Reserve of the United States Paul Volcker’s aggressive economic and political interventions during the 1970s and 1980s to combat stagflation, where global attention was drawn to central banks’ ability to manage more than macroeconomic conditions, illustrating political perspective to the story that complements a narrative approach emphasizing a technocratic view of central banks by taking a political stance.

Moschella examined the United States Federal Reserve (Fed) and the European Central Bank (ECB) to illustrate her arguments. She argued that central banks make critical decisions based on political circumstances, not just new economic ideas or absolute independence. Regarding controversial decisions, Moschella contended that central banks undertake disputed actions only when they have government backing. This political cover allows them to pursue unconventional policies without jeopardizing their public image. The specific forms of government support differ between the US and Europe due to their varying political landscapes. Conversely, central banks might make more contentious decisions concerning controversial decisions and public backlash, like addressing climate change (ECB) or social inclusion (Fed), in response to negative public sentiment. Here, they are reacting to public pressure rather than leading the charge. A central bank may use unconventional tools and revise its monetary strategy to acquiesce to public discontent; for example, after the 2008 global financial crisis, inclusive growth was added to the Fed’s stated objectives. Likewise, the ECB addressed climate change through banking supervision of non-financial reporting, reforming collateral eligibility and developing macroeconomic knowledge addressing climate change. The dual roles of a central bank – asserting independence while at the same time seeking political legitimacy – make it a peculiar institution in the world of finance.

Moschella also mentioned that, although her analysis significantly uses the Fed and ECB as examples of central banks focusing on issues beyond inflation, there is a small section in her book about the Bank of Japan and its historical experience with deflation. While deflation is not a center-stage topic – since most of the thinking on central banking, both in economics and political science, is about credibility in fighting inflation – it is relevant in the context of unconventional policies. The Bank of Japan is particularly significant because it was one of the only high-income countries to confront deflation, though this issue continues to remain at the margins. This example illustrates her desire to understand and chart how central banks emerged as distinct political institutions across the world.

Additionally, Moschella stressed the necessity of maintaining a strong relationship between central bankers and political principles so that monetary and fiscal policies can be coordinated in a way that maintains the central bank’s independence. There is no doubt that political support of monetary policies, especially the quantitative easing regime, is of paramount importance during times of distress. On the other hand, if political leaders become hostile towards bankers, the public’s trust in central banks will decrease, making it harder for them to stabilize the economy.

Subsequently, in Q&A portion of the discussion, Moschella answered the question of what the primary policy of a central bank should be: inflation or financial stability? Moschella pointed out that the context of the economy matters; for example, the Fed was created when financial stability was a crucial concern, and the ECB was created when price stability was the central issue, and she emphasized that these mandates have evolved over time and have potential tradeoffs. For example, central banks might be reluctant to increase interest rates even if it is necessary because it may be detrimental to financial stability. Thus, although the mainstream mandate of central banks is the stability of prices, they prioritize other areas depending on the macroeconomic context, and politics and society decide the priority.

Regarding the question about the differences in mandates of central banks between the Global North and Global South, Moschella highlighted that developing countries tend to implement more unconventional monetary policies because they might also be concerned about economic development over price stability to facilitate social goals. However, countries in the Global North also deviated from the price stability mandate when it was required. For instance, after World War II, the Italian government pursued economic development as its primary objective. Consequently, Italy used central bank credits, credit allocation policies and interest rates to support the development of particular industries and technologies. Therefore, according to Moschella, it is up to the governments to decide the direction in which the central banks should be heading.  

Overall, the book challenges the notion that central banks solely respond to financial markets. While that has occurred at times, Moschella highlighted critical moments where governments and citizens significantly influence central bank actions, pushing them towards specific goals. The author finally pointed out that this perspective on central banks as political institutions necessitates a broader understanding of their decision-making processes. They are not isolated entities driven solely by technical expertise. Instead, they operate within a complex web of political influences, needing to consider the demands of various stakeholders to ensure their continued effectiveness.

*

Never miss an update: Subscribe to the Global Economic Governance Newsletter.