By: Dr. Mike Campbell
With unilateral moves taken by Germany to ban naked short-selling and more in the pipeline; musings by the European Commission on regulating ratings agencies and open discussions on a banking levy to fund future financial crises (which presupposes that lessons will not be learned from the current debacle), Federal Reserve Chairman, Ben Bernanke, has warned against political meddling with the central banks.
In many countries, the central banks are given independent control over certain, key, economic decisions such as the setting of bank interest rates. Essentially, this has occurred to dissociate politicians from the charge of interfering with the markets; received wisdom being that market forces will settle most problems, if left to their own devices.
However, that viewpoint has been held up to public scrutiny in the aftermath of the current global crisis. Bernanke argued that any restriction on a central bank’s ability to control interest rates could lead to economic instability and “boom and bust” cycles. He also rejected a proposal that the target inflation rate should be relaxed from 2% to 4%. Proponents of the move argue that it would give central banks more room for manoeuvre in a financial crisis since it would allow interest rates to float up somewhat. The argument is that with bank interest rates currently at all-time lows, central banks have limited room to affect the markets and such a decision could provide a tool to deal with deflationary pressure.
A rally on world stock markets was underway yesterday, however it ran out of steam in New York when rumours began to circulate that Chinese authorities were reviewing its position of holding Euro-denominated debt. However, it is unlikely that it would seriously unwind its position since this could lead to a substantial devaluation of the currency which would devalue the Chinese holdings. It is perhaps just as likely that the Chinese will take the view that the Euro will recover and increase their holdings.