How Financial Power Really Works: Central Bank Predictability and the Management of Expectations

This paper examines the rise of finance and its increased influence over central bank policy in the post-Bretton Woods era. The institutionalization of independent central banks under financial globalization has accompanied the emergence of global finance as a major constituency in the making of monetary policy. There is a near consensus among scholars that independent central banks provide benefits for financiers. Despite this consensus, we still know very little about the processes and mechanisms by which the financial community influences monetary policy decisions. Monetary policymaking and how central bankers interact with financial interests remain a ‘black box’.

This paper develops a theoretical framework to unpack the power relationship between the central bank and the financial community. It conceptualizes financial interests based on “fictional expectations” (Beckert 2013). It examines how financial power operates over monetary policymaking, describing it as a repetitive, sequential power game between the central bank and financiers. This game involves the management of expectations where credibility is an important resource to policymakers. Central bankers build credibility through predictability of their policies. The paper argues that while monetary policy predictability serves financial interests, paradoxically it also endows the central bank with the capacity to shape the financial community’s expectations in line with its policy goals and pursue independent monetary policy. The paper applies Alford and Friedland’s (1985) theory of three forms of power to discuss the contours of this policy space.

The paper illustrates the theoretical framework using a deviant case, the Central Bank of Turkey (CBT). The CBT introduced an unconventional policy framework in 2010 following the 2007-2008 Financial Crisis in light of its shifting priorities away from inflation, and toward economic growth. Under the new framework, it intentionally created uncertainty around its future interest rate decisions, ‘surprising financial markets’ and rendering monetary policy unpredictable. The paper examines the inception, workings and the eventual decline of the unconventional policy in 2014. It uses public texts and over ninety semi-structured interviews with Turkish central bankers, and financiers in Turkey and London.

The paper finds that the CBT promoted uncertainty to deter the surge of hot money flows, which resulted from major central banks’ expansionary policies following the crisis. The unconventional policy provoked fierce criticism from financiers as unpredictability threatened the profitability of financial investments. However, the CBT’s policy surprises eroded its credibility, gradually shrinking its capacity to guide the economy. The CBT could not successfully manage the financial community’s expectations in consonance with its policy goals. It returned to monetary policy orthodoxy in 2014 due to growing financial panic and deteriorating business confidence in the economy. Abandoning policy surprises, it was forced to validate the financial community’s expectations of future monetary policy decisions. While validating financiers' expectations itself enacted financial influence over monetary policy, it was also a step toward rebuilding its credibility to effectively govern the economy. Finally, the paper explores why the CBT, unlike other central banks, chose to use uncertainty as a policy tool and how this policy framework was maintained over a considerable period of time.