Central Bank independence in today’s world - Speech by Andrew Bailey

It is a great pleasure to be here in Zurich.

The main focus this evening is to have a discussion. I am just going to make a few opening comments across the subjects of central bank independence, financial stability and technology – as a prompt to get our discussion going.

We are living through difficult times. Imagine if any of us had been asked ten years ago what were the odds of major military conflicts in Europe and the Middle East at the same time. The economics of these events are supply shocks – which tend to push prices and inflation up and activity down at the same time. Such shocks are challenging for central banks, and particularly when they are large and more frequent. A shock prone world is more difficult.

At the same time, we are seeing growing signs of the beginnings of a positive supply shock coming from AI and the investment required for that. In the UK, economic activity is turning out to be more resilient than we had expected, and some of that is due to AI investment, particularly in the business services sector.

These are challenging times for independent central banks setting monetary policy and for the people we serve. These shocks push inflation away from our targets – our definitions of price stability. Our task is to set interest rates to bring inflation back to target. I do recognise that in Switzerland you have experienced a record of more subdued inflation.

When it comes to the independence of central banks, I would say two things. Yes, these conditions are more challenging. But, it is in the challenging times that we need robust institutions more than ever.

There is though an important further step in this line of argument, which may seem obvious but needs stating. As independent institutions, we are not independent of the people of our countries. We serve them and are accountable to them. This is our public legitimacy. And by this I mean the whole people. I think our independence and legitimacy depends on this – we don’t and shouldn’t select those whom we serve and we are therefore inherently plural in our approach to our societies. This is a critical feature of independence.

Let me turn now to financial stability and central bank independence. Monetary and financial stability are in my view inseparable as the core principles of central banks. They are both equally and firmly anchored around the stability of the value of money. But, notwithstanding this in my experience, the political economy of independence is different. When it comes to monetary policy, while there can be debate around the form and precise structure of the arrangements, the independence of the actual decisions on interest rates is not in doubt. But this does not carry over to financial stability, where the decisions are much more contested. The lobbying moreover is much louder, and the interests much more sharply defined I would argue.

This is illustrated by the current state of affairs. Memories of the financial crisis are receding. But it is contributing to pressure to ease back regulation. I don’t pretend that every one of our rules and regulations in the UK is perfect.

But, I do contend that sustained economic growth depends on financial stability. So, it matters. It also matters that so far we have come through the latest adverse economic shocks with a resilient financial system. That’s not an accident. The post crisis regulatory reforms have made a difference here. And, the final “it matters”, we are seeing the risks shift into new areas of the financial landscape.

Which brings me to my last subject – technology, and particularly AI. I am an optimist on AI, digital technology and most probably robotics too. They have the potential to lift the sustainable growth rates of many economies through raising productivity growth. That is a good thing.

But with that do come risks, the risks of how to come to terms with AI for instance. In our world, Frontier AI has increased the risk from cyber-attacks – something that was already prominent. More broadly, it has led to concerns which may call into question public trust in AI. This is critical. We must act promptly to identify ways to give the public the level of trust they want and deserve. To achieve this, we must be clear what public interest objectives we are pursuing and how we achieve them. A clear case for me is that we need more extensive model testing, pre and post release. This may lead us to conclude that we want more or different points or means of human user intervention in the operation of AI. We also certainly want better incident reporting, monitoring and follow up (to make sure we learn the lessons from them). The key point is that public trust will depend on assured human intervention. AI will succeed as a tool of humans.

Why does this matter for central banks you may well ask? It matters a lot I would argue. Let me briefly set out two reasons for this, which are closely interconnected, and linked to financial stability.

Throughout modern history there has been a close relationship between economic growth, the interest of businesses in fuelling that growth, and the public interest as defined and represented by governments and in some areas of public policy put into effect by institutions such as central banks. You don’t need to take any ideological position to believe in this nexus of connections – you could be Hayek, Keynes, Marx or Schumpeter.

The question we face today is whether AI poses a new and more forceful challenge to the nexus, in the sense that the risk of a loss of public trust requires a careful but determined response to underpin that trust and support the economic growth that we all want to see? My response to this question would be yes it does pose such a challenge. Put simply, if you say “very good things can come from this, but bad things may happen too”, you can’t leave it there. And, it deepens the dependency between commercial success and public policy.

But second, and finally, there is a powerful connection to financial stability here. There is a lot of speculation on the subject of whether there is an asset price bubble in AI, and the financial stability risks that go with that. Bubble spotting is an imprecise science. But, let’s recognise that such a risk exists, which we should do. How might the bubble burst and potentially cause a problem? Four arguments can I think be advanced here.

First, it is the job of financial markets to value uncertain future returns. The returns from AI may be good, but still markets may overvalue them. That’s in the nature of the task of valuing uncertainty.

Second, the returns may be good, and they may match expectations, but they take longer to be realised than predicted. This has been the case historically with big General Purpose Technology innovation – take Edison and electricity for instance. There are good reasons to believe that the world moves faster now, but still the timing may not live up to market expectations.

Third, everyone is priced to be a winner, but history tends to tell us that this is not the case. Remember Netscape.

Fourth, the public trust point – there is a certain fragility created by this nexus. Arguably it is not new. A British Prime Minister was killed by one of the earliest steam locomotives, people worried about the dangers of electricity. I would argue that at present the argument seems more powerful with AI – but as I noted earlier, I treat that as a problem to be solved. But, until we have done so it could affect asset valuations.

So, there are clear financial stability risks here, and that’s without talking explicitly about cyber risks.

I said I would use my opening remarks to stir up some questions. Let’s see!

I would like to thank Sarah Breeden, Karen Jude, Clare Lombardelli, Dave Ramsden and James Talbot for their assistance in preparing these remarks.