Should central banks worry about profits and losses?

Around the world, central banks’ balance sheets are becoming
an increasingly serious concern – most notably for monetary
policymakers themselves. When the Swiss National Bank (SNB)
abandoned its exchange-rate peg last month, causing the franc
to soar by a nosebleed-inducing 20%, it seemed to be acting out
of fear that it would suffer balance-sheet losses if it kept
purchasing euros and other foreign currencies.
Similarly, critics of the decision to embark on quantitative easing
in the eurozone worry that the European Central Bank is
dangerously exposed to losses on the southern eurozone
members’ government bonds. This prompted the ECB Council to
leave 80% of those bond purchases on the balance sheets of
national central banks, where they will be the responsibility of
national governments.
In the United States, meanwhile, the “Audit the Fed” movement is
back. Motivated by growth in the Federal Reserve’s assets and
liabilities, Republicans are introducing bills in both chambers of
Congress to require the Fed to reveal more information about its
monetary and financial operations.
But should central banks really worry so much about balance-
sheet profits and losses? The answer, to put it bluntly, is no.
To be sure, central bankers, like other bankers, do not like
losses. But central banks are not like other banks. They are not
profit-oriented businesses. Rather, they are agencies for
pursuing the public good. Their first responsibility is hitting their
inflation target. Their second responsibility is to help close the
output gap. Their third responsibility is to ensure financial
stability. Balance-sheet considerations rank, at best, a distant
fourth on the list of worthy monetary-policy goals.
Equally important, central banks have limited tools with which to
pursue these objectives. It follows that a consideration that
ranks only fourth in terms of priorities should not be allowed to
dictate policy.
Indeed, a clear understanding of their priorities has often led
central banks to incur losses when doing so is the price of
avoiding deflation or preventing the exchange rate from
becoming dangerously overvalued. The Chilean, Czech, and
Israeli central banks, for example, have operated with negative
net capital for extended periods without damaging their policies.
The reason why adverse consequences need not follow is that
the central bank can simply ask the government to replenish its
capital, much like when a government covers the losses of its
national post office. Everyone is happier when transfers flow the
other way. But the role of the central bank is not to be a profit
center, especially when those profits come at the cost of other,
more important policy objectives.
All of this makes it hard to fathom what the SNB was thinking.
The sharp appreciation of the franc threatens to plunge the
Swiss economy into deflation and recession. The risk of balance-
sheet losses for the SNB, with its euro-heavy portfolio, may be
greater now that the ECB has embarked on quantitative easing.
But this is no justification for abandoning its mandate to pursue
price and financial stability.
The SNB’s motive, it appears, was entirely political. Last year,
the SNB was dragged into the highly charged debate surrounding
a referendum on a “gold initiative” that would have required it to
increase its gold reserves to 20%, and limited its ability to
conduct monetary policy. One rationale for the initiative was to
bullet-proof the SNB’s balance sheet against losses. This goal
was especially dear to the cantons, the states of the Swiss
Confederation, which rely on transfers from the SNB for a
significant share of their budgets.
The “gold initiative” was voted down, but the political debate was
traumatic. In January, with the accelerating depreciation of the
euro, the debate flared up again. The fear was that the SNB’s
balance-sheet losses might anger cantonal leaders to such a
degree that the central bank’s independence would be
threatened.
Whether true or not, the political salience of the issue
underscores the dangers of an arrangement that precludes the
SNB from focusing fully on economic and price stability. The
obvious solution is not to abandon the franc’s euro peg, but to
change the cantonal financing mechanism.
And, to those who are concerned for the SNB’s independence,
one might ask a fundamental question: What is independence for
if not to ignore those who complain that the central bank is
insufficiently profit-oriented?
The same criticism applies to the loss-sharing arrangements that
the ECB attached to its quantitative easing. The ECB’s priority
should be to avoid deflation, not shield its shareholders from
losses. The 80/20 loss-sharing arrangement with the national
central banks may have made quantitative easing more
palatable in Germany, but it casts doubt on the unity of the
eurozone’s monetary policy. In a context in which the ECB is
seeking to “do whatever it takes” to vanquish deflation, this is an
unhelpful complication.
Central bankers are praised softly when they make profits and
criticized loudly when they incur losses. They should have the
good sense to ignore both the criticism and the praise.
Particularly now, the world’s monetary policymakers have far
more important problems to address.