Central Banks Do Not Prevent Financial Crises or Control Inflation
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The guest commentary below was written by written by Daniel Lacalle.
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Central banks have become the dominating force in financial markets.
Easing and tightening decisions move all assets from bonds to private
equity. Their role is supposed to be to control inflation, provide
price stability, and ensure normal market functions. However, there is
little evidence of any success in achieving their goals. The era of
central bank dominance has been characterised by boom-and-bust cycles,
financial crises, policy incentives to increase government spending and
debt, and persistent inflation. Recently developed economies’ central
banks have taken an increasingly interventionist role.
The creation and proliferation of central banks over the past century
promised greater financial stability. Nevertheless, as history and
current events continually show, central banks have not prevented
financial crises. The frequency and severity of these crises have
fluctuated but have not declined since central banks became the leading
figure in financial market regulation and monetary interventions.
Instead, central banking has introduced new fragilities and changed the
nature, but not the recurrence, of financial turmoil.
Empirical evidence dispels the myth that central banks ended the era
of frequent financial crises. Regardless of central bank oversight, a
credit boom preceded one in three banking crises. Who created those
credit booms? Central banks, through the manipulation of interest rates.
According to Laeven and Valencia’s comprehensive database, there were
147 banking crises between 1970 and 2011 alone, in an era of
near-universal central bank dominance. Financial crises remain a
persistent global phenomenon, occurring in cycles that coincide with
episodes of credit expansion. Central banks have often prolonged boom
periods with low rates and elevated asset purchases and created abrupt
bust moments after making mistakes about inflation and credit risks.
According to Reinhart and Rogoff’s work,
the rate of crises has not dramatically changed with central banking.
Instead, the forms of crises evolved. Twin crises (banking and currency)
remain common, and the severity, measured in output loss or fiscal
costs, has often increased, especially as financial institutions and
governments grew intertwined with monetary authorities.
The Great Financial Crisis of 2008, the Eurozone sovereign debt
crisis, and the 2021–2022 inflationary burst rank among the events with
the highest costs in history, contradicting the view that central banks
have neutralised the risk or costliness of crises.
Central banks act as “lenders of last resort” and regulators.
However, with each subsequent crisis, the solution is always the same:
larger and more aggressive asset purchase programmes and negative real
rates. This means that central banks have gradually moved from lenders
of last resort to lenders of first resort, a role that has amplified
vulnerabilities. Due to the globalisation of modern central banking and
financial innovations, crises tend to be larger in scale and more
complex, impacting most nations. The profound involvement of central
banks in markets means their policies, such as emergency liquidity or
asset purchases, mask systemic risks, leading to delayed but more
dramatic failures.
In many advanced economies, recent waves of
crises were triggered by debt accumulation and market distortions
engineered by central banks, often under the guise of maintaining
stability. The IMF and World Bank both note that about half of debt
accumulation episodes in emerging markets since 1970 involved financial
crises, and episodes associated with crises are marked by higher debt
growth, weaker economic outcomes, and depleted reserves—regardless of
central banking.
Major crises in recent decades have highlighted that central banks do
not prevent systemic disruption. Often, their interventions have only delayed the
reckoning but made underlying imbalances, particularly government debt,
worse. Central banks do not prevent financial crises. They reshape
them, often making their consequences more far-reaching, while shifting
the costs onto the public through inflation and debt monetisation.
The Growing Priority: Supporting Government Over Managing Inflation
As I argued recently, central banks are increasingly prioritising
government debt distribution over combating inflation. Central banks
have one priority: keeping the government debt bubble alive. Central
banks constantly inject liquidity to stabilise sovereign issuers rather
than uphold price stability. In 2025 alone, global debt maturities will
reach nearly $2.78 trillion, and central banks are expected to continue
easing monetary policies, even as inflation proves persistent.
Central banks use their enormous power to disguise the insolvency of
sovereign issuers and make their debt pricier, which leads to the
subsequent excessive risk-taking and asset price inflation. Furthermore,
the idea that low rates and asset purchases are tools that help
governments reduce their fiscal imbalances and conduct budget prudence
is negated by reality. Artificially low rates and asset purchases
justify persistent deficits and high debt.
Central banks are enabling inflation and financial instability when
they should be restraining it. By ignoring monetary aggregates and the
risks created by rising government intervention in the economy and
currency issuance through debt instruments, central banks are enabling
the slow-motion nationalisation of the economy.
The misguided central bank monetary expansion and negative rate
policy of 2020, perpetuated well into 2022 despite soaring inflation, is
a clear example. Governments benefited in the period of expansion with
enormous debt purchases that enabled an ill-advised increase in
government spending and debt. Meanwhile, citizens and small businesses
suffered from high inflation. Thus, when central banks finally
acknowledged the inflation problem they helped create, they kept loose
policies prioritising liquidity, which fuelled more government
irresponsibility, and the rate hike damaged the finances of families and
small businesses that previously suffered the inflation burst.
Governments weren’t concerned about rate hikes because they increased
taxes.
The Federal Reserve’s response to increasing government deficits has
consistently favoured greater government intervention and rising debt
levels, even at the expense of higher inflation, which has undermined
its independence and credibility.
Independence vanished when central banks abandoned or ignored price
stability, blaming inflation on various absurdities instead of
government spending and money supply growth.
The Bank of England, for example, keeps cutting rates and easing policy with rising inflation.
Central banks tend to ease monetary policy when governments increase
spending and taxes. However, policymakers claim to be data-dependent and
strict when governments reduce taxes and spending. Why? Central banks
have transitioned from being independent monetary authorities
safeguarding the currency’s purchasing power and controlling inflation
to facilitating the distribution of rising government debt and
disguising rising issuer insolvency.
Modern central banking has shown that no single authority should set
interest rates and liquidity. They have consistently erred on the side
of rising government size in the economy and made erroneous estimates of
inflation and job growth. The reason for this is straightforward: as
the size of government in the economy and sovereign debt, which is often
considered the safest asset, increase, the central bank’s role becomes
increasingly important for maintaining market stability.
Many central banks state that they don’t interfere with fiscal policy
and remain independent… except when someone dares to cut taxes and
political spending. As such, central banks are not a limit to
risk-taking, rising government spending and budget irresponsibility, but
rather a tool that enables market and government excess.
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尽管如此，北京与喀布尔方面似乎都试图维持双边关系的总体稳定。
