A survival guide for central bankers

Vivek Sharma
13 December 2007

Rules central bankers may follow to survive in this uncertain, complex and perplexing world and hang on to their jobs.

US Fed chairman Ben Bernanke is being pilloried for delivering more or less what the markets genuinely expected this week. His fault was that he failed to exceed market expectations and it was made clear in no uncertain terms that it was highly disappointing behaviour from a central banker.

Central bankers must be among those who face unfair criticism the most. Their job has become highly challenging for no fault of theirs, but because many people now believe that the world has become flat. A flat world must be logically more straightforward and therefore less complex than a round one.

But, modern day financial markets thrive on complexities and market participants race against each other to invent even more innovatively complex financial instruments or securities. The flatter they assume the world is the more complex their inventions become, as if to maintain the overall level of complexity in our lives.

Central bankers are expected to figure out when the most complex instruments, which even their inventors do not fully understand, will begin to appear risky and make the markets nervous. Then, they have to find a way to ease the nerves and help markets regain normalcy. As fear is one of the more difficult human emotions to master, central bankers haven't quite figured out which of their weapons of market management would work and which wouldn't, and under what circumstances. Their approach remains more a trial and error one and they always take the safer option.

The only way for central bankers to be effective is to anticipate future trends and line up their weapons accordingly. That is what many generations of central bankers have tried to accomplish with varying degrees of success. But, these days they are not allowed to do so. Financial markets have invented instruments to let central bankers know what is expected of them. If any central banker has the temerity to go ignore the signals from the derivatives market, he will be screamed at on public television, called names or otherwise threatened into submission.

So, the once mighty central bankers are a scared lot and are more than willing to oblige the markets. It has come to such a state that 30 of the last 32 interest rate decisions of the US Fed have been in line with market demands as expressed through the fed rate futures on the CBOT. And in one of those two exceptions, the Fed exceeded the markets' brief when it cut rates by 50 basis points this September when the derivatives markets predicted a 25 basis points cut.