Blanchard Cautions Central Banks May Become ‘Too Powerful’

International Monetary Fund Chief Economist Olivier Blanchard cautioned that independent central banks may become “too powerful” as they gain new responsibilities in the wake of the global financial crisis.

While central banks’ mandates used to be confined to monetary policy with a focus on interest rates, they how have an increasing set of tools, including some concentrating on the financial sector, Blanchard said in a speech at the London School of Economics.

“Do you actually want to give the independent central bank the right to choose loan-to-value ratios without any supervision from the political process?” Blanchard said on a panel that also included Federal Reserve Chairman Ben S. Bernanke. “Isn’t this going to lead to a democratic deficit in a way, in which a central bank becomes too powerful?”

European Union lawmakers and national governments earlier this month reached a provisional deal on legislation to turn the European Central Bank into a supervisor. The move, which paves the way for the currency bloc’s firewall fund to provide direct bailouts to banks, is part of efforts to tame the fiscal crisis that has forced five countries to seek international aid.

Ways Out

“I’m sure there are ways out, in which there could be independence with respect to some dimensions of monetary policy, maybe the traditional ones, and some supervision for the rest, or some interaction with the political process for the rest,” Blanchard said of central banks. “These are all issues that we’re all struggling to try to understand and think about.”

Axel Weber, the chairman of UBS AG and former president of Germany’s Bundesbank, also expressed concern about new central-bank powers.

As central banks take on a greater role in banking supervision and get a “key place” in financial markets, it “heightens the risk that if a central bank gets it wrong, they get it wrong across a whole range of areas,” he said, speaking on the same panel.

“It’s a complex problem,” Weber said. “It’s something that central banks have to weigh very carefully. I wouldn’t risk the independence of an institution.”

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