Book review: “Central Banking in Turbulent Times”

“Central Banking in Turbulent Times”, by Francesco Papadia with Tuomas Välimäki;  OUP 2019.  Link here

Summer is traditionally a time for lazy holidays and a chance to catch up on some reading.  And while for most people the books of choice will be light and not too demanding, for some it is also an opportunity to spend time away from the distractions of normal life studying more serious works.

The latest book by Francesco Papadia, “Central Banking in Turbulent Times”, which he has co-authored with Tuomas Välimäki of the Bank of Finland, is unashamedly one of the latter.  Papadia was Director General for Market Operations at the European Central Bank from 1998 to 2012, and before that at the Banca d’Italia, first as Director of the International Section of the Research Department and then as deputy head of the Foreign Department;  he is both very experienced in the practice of central banking and a deep thinker about its theory.  It is not surprising then that in this his latest book, he has brought both his theoretical analysis and his practical experiences together.

The result is a book which is detailed and thoughtful enough for the expert while being neither too long nor too heavy for the interested observer.  The first part of the book is as good a summary of classical central banking as it was at the end of the Great Moderation in 2006 as I have read, and the middle section, the most substantial part of the book, is a rich store of insights and analysis of central banking in the Financial Crisis.  This was the most interesting decade for central bankers certainly since the 1930s and possibly, given that central banking was less developed then, the most interesting ever, and not only do Papadia and Välimäki analyse the conceptual and practical challenges central banks faced, they have also added copious data to support the analysis.  It will be a text book for future central bankers.

Papadia’s ability to recall the period of the Financial Crisis in such detail, given that he was “in the trenches” at the time, is remarkable.  And he has used the years since he retired from the ECB to marshal his thoughts and analyse and interpret the actions of the ECB and other central banks well.  The result is a coherent assessment of the various operational actions taken to meet the multiple challenges to the financial system over the twin crises of 2007-09 in the US and 2011 onwards in the Eurozone.

Indeed it is perhaps almost too coherent – one possible comment here is that chapter 2 does not fully capture the sense of shock, bewilderment, impotence even that central bankers initially had when the numbers went off the chart.  But events often feel chaotic and bordering on running out of control as they unfold, and Papadia’s skill is to show the underlying rationale that underpinned the seemingly disparate actions that central banks took in response.

If the heart of the book is a blow-by-blow account of what central banks did to overcome the Financial Crisis, the final section is a detailed consideration of the state of central banking now that they have done so.  Papadia’s overall conclusion here is that the unconventional actions the central banks have taken over the last decade or so have not only changed the way central banks think and operate, but also, and more significantly, changed society’s expectations of what a central bank can do.  The innovative techniques used over the last decade cannot be uninvented;  they will always now be part of a central bank’s arsenal, and society is aware that they exist and will expect them to be used where necessary.

Papadia and Välimäki are also unafraid to pose some more political questions.  This includes the peculiar type of moral hazard that the ECB was caught by, when it was forced to act well beyond its comfort zone by the inactivity of the political class.  He hints at both the pressure that the ECB was under as the EU political leadership played a game of “chicken” with the bank (forcing it to act to avoid a disaster which was as much as anything caused by the failure of the politicians to themselves act), and the result of its actions, as they merely gave the political class further reasons to delay taking the steps they could/should have done to alleviate the pressure on the ECB as “the only game in town”.

It must have been a frustrating experience, and it is perhaps a shame – though entirely understandable – that Papadia is slightly reticent here in saying what he no doubt really thinks!

But he does use it to lead into a discussion of one of the major questions that the Crisis has posed, which is whether the independence of central banks is an unqualified good in a democratic society.  Did the ECB go beyond not just its technical remit but also its democratic remit, as many in Germany claimed?  Independence is not a given for central banks, and the pendulum can and at times in the past has swung back towards closer oversight – not least, for example, when the Bank of England was nationalised in 1946.  It is therefore legitimate to ask whether, as central banks take on more roles and are faced with more choices, their accountability once again needs to be strengthened, and they need to be brought more closely again under the scrutiny of the democratic process.

The authors’ closing thoughts are on the international role of central banking.  One of the features of the central banking community’s response to the Crisis was the degree of co-operation between the various central banks, and the book asks whether this will continue.  The realistic answer to this is that central banks will always concentrate on the needs of their own financial system first and foremost, unless and until problems overseas in other jurisdictions once again threaten instability in their home jurisdiction.  The question then becomes a one of how global the world financial system remains;  if it does, then leading central banks will have to retain a global awareness, but as we head into a more populist and autarkic world this is by no means guaranteed.

In summary, this is a book which will inevitably be mainly bought by and read by those working in finance.   And they, especially central banking practitioners, will derive huge benefit from it.  But it deserves a wider audience too;  there is much here for the interested generalist, and the conclusions will help shape the world’s financial system for many years to come.