Why Are Central Banks on Trial Again?

LONDON – Central banks have been on a roller-coaster ride in the last decade, from heroes to zeroes and back again. Is another downswing in their fortunes and reputations now starting?

In 2006, when Alan Greenspan retired after his 18-year reign as Chair of the US Federal Reserve Board, his reputation could hardly have been higher. He had steered the US economy through the dot-com boom and bust, had carefully navigated the potential threat to growth from the terror attacks of September 11, 2001, and presided over a period of rapid GDP and productivity growth. At his final Board meeting, Timothy Geithner, then-President of the New York Fed, delivered what now seems an embarrassing encomium, saying that Greenspan’s stellar reputation was likely to grow, rather than diminish, in the future.

Only three years later, the Nobel laureate economist Paul Krugman, borrowing from Monty Python’s parrot sketch, was able to say that Greenspan was an ex-maestro whose reputation was now pushing up daisies. Central banks were widely seen to have been dozing at the switch through the early years of this century. They allowed global imbalances to build up, looked benignly on a massive credit bubble, ignored flashing danger signs in the mortgage market, and uncritically admired the innovative but toxic products devised by overpaid investment bankers.

The early reactions by central banks to the deepening crisis were also unsure. The Bank of England (BoE) lectured on moral hazard while the banking system imploded around it, and the European Central Bank continued to slay imaginary inflation dragons when almost all economists saw far greater risks in a eurozone meltdown and associated credit crunch.