Central Banks’ Day of Reckoning Is Here

TÜBINGEN – As energy prices continue to decline and the base effect of last year’s price increases takes hold, inflation rates across the Western world are expected to fall. Even so, prices will likely remain unacceptably high for the foreseeable future, making true price stability a distant prospect.

Moreover, rising wages and ongoing geopolitical tensions, together with long-term structural factors such as demographic trends and deglobalization, are expected to keep inflation expectations above central-bank targets, burdening Western economies and societies in the long run.

Now is the time for central banks to take decisive action and improve their communication strategies. Policymakers must urgently explain the reasons for the current high inflation, its consequences, and the measures taken to address it. This communication must not be limited to market participants, as citizen engagement is just as important, if not more so. After all, citizens are central banks’ most important partners in fighting inflation and protecting their own independence.

Effective communication requires a significant amount of insight, self-criticism, and humility. In the past, central banks have made mistakes, such as misdiagnosing a period of price stability as an episode of unacceptably low inflation. Their asymmetric monetary policy over the past several decades, which resulted in progressively lower interest rates, reduced their potential room for maneuver and led to significant market distortions. Yet, despite evidence of harm caused by their ultra-expansive policy of low interest rates and massive balance-sheet expansion, central bankers repeatedly postponed ending it.

Policymakers were far too slow to recognize the inflationary forces unleashed by COVID-19-related supply-chain disruptions and the war in Ukraine. Neglecting or overlooking critical economic and monetary indicators, they considered the price surge to be a “transitory” phenomenon that required no immediate action, and markets and the public were given misleading signals that interest rates would be kept low until 2024. Because of these misdiagnoses and the delayed response to inflation, central banks had no choice but to pursue aggressive interest-rate hikes that caught market participants off-guard and led to distortions.

By deviating from their core mandate of ensuring price stability to pursue other, unrelated policy goals, central bankers, once celebrated as heroes, have severely damaged their credibility. Particularly among eurozone countries, their analytical failure and professional misjudgment have called into question the reliability and effectiveness of their policymaking and recommendations to governments.

To regain the public’s trust, central banks must abandon their monetary ivory tower. As interesting as lectures at universities and research institutions can be, their primary role is to affirm central bankers’ own importance. But jargon-heavy academic discourse will not help central banks win over the general public. In its 2021 strategic review, the European Central Bank stated that it should use more accessible language in future communications, educating the public on complex issues without oversimplifying them. Unfortunately, the ECB has not updated its language or become more citizen-friendly since then.

The ECB, responsible for ensuring price stability across 20 European countries, has become far too removed from the public it serves and must make a far greater effort to bridge the gap. Because it communicates mainly in English, every oral and written statement must be translated into national languages, and the task of public engagement mostly falls on national central banks, though this role is not clearly defined. In the pre-euro era, central banks communicated with citizens more effectively, sustaining a level of trust that the ECB currently lacks.

But national central banks have become even more alienated from the public since the euro was introduced almost 25 years ago. National monetary policymakers have failed to serve as effective information brokers, partly owing to internal disagreements within the ECB Governing Council. While using these disagreements as an opportunity to rally public support for dissenting views would have been problematic in the ECB’s startup phase, that is likely no longer an issue now that the bank has matured.

In times of high inflation, it is crucial to re-establish the bond between national central banks and the public. To achieve this, banks must shed unnecessary tasks, free up capacity, focus solely on their core mandate, and launch comprehensive public outreach campaigns. But central banks cannot restore their credibility and win back the public’s trust unless they take responsibility for and learn from their past mistakes.

Unfortunately, it seems that central banks are not willing to engage in this necessary process of self-reflection. To date, only the Reserve Bank of Australia has acknowledged its previous policy errors and taken steps to increase citizen engagement. Other central banks should follow the Australians’ example – and hope that the damage caused by their past mistakes is reparable.

Jürgen Stark, a former member of the ECB Executive Board and Governing Council, is a former deputy governor of the Deutsche Bundesbank and honorary professor at the University of Tübingen.

Copyright: Project Syndicate, 2023.
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