Latest / Monetary Policy Explained with Fexingo: Central Banks, Money Supply, and Interest Rates / How Central Banks Use Moral Suasion
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- Lucas: You ever hear about the Bank of England's 'governor's eyebrow'? It's not an anatomical quirk — it was the threat of a raised eyebrow from the governor that kept banks in line for decades. No regulation, no law, just a look. Luna: Right — the idea that if the governor frowned at you, your next funding round got a lot harder. That's moral suasion, isn't it? The quiet arm-twist. Lucas: Exactly. And it's one of those tools central banks never really codify, but they use all the time. Today I want to walk through how moral suasion actually works — not the press conference version, the off-the-record phone call version. Lucas: But first — if walking through the economy with us has made something click, the way this show stays ad-free and independent is listener support. It's buy me a coffee dot com slash fexingo. That's all — just a way to keep it going if you find it useful. Luna: Yeah, it genuinely makes a difference. And it keeps us from having to run those obnoxious programmatic ads. Lucas: So — moral suasion. The classic definition is a central bank using its influence, not its balance sheet, to change bank behavior. The Bank of England perfected it in the post-war period. They'd call up a bank chairman and say, 'We'd prefer if you didn't increase your lending to property developers this quarter.' No legal force. Luna: But the bank knew that if they ignored the call, the next time they needed emergency liquidity, the governor might be less helpful. It's a reciprocity game. Lucas: Exactly. And it worked because the financial system was small, clubby, and the central bank had a monopoly on lender of last resort services. But the world changed — bigger banks, global markets, more players. So does moral suasion still have teeth? Luna: Let's take a recent case. The Bank of Japan in 2024 — they were worried about regional banks piling into Japanese government bonds, basically betting on yield curve control. So they started making direct appeals to those banks to diversify their holdings. Lucas: Right. The Bank of Japan didn't impose a hard limit. They just said, in very polite Japanese, 'We think it would be prudent for you to reduce your JGB exposure.' And the regional banks — many of them did. Why? Because the BOJ is also their supervisor. They approve branch expansions, they sign off on senior hires. Luna: So it's regulatory capture in reverse. The bank complies because they don't want to get on the wrong side of the people who approve their business plans. Lucas: That's the mechanism. And it's not unique to Japan. The Reserve Bank of India used moral suasion in 2023 to get banks to lower lending rates even though the repo rate was high. They just called the CEOs and said, 'We expect you to pass on the rate cuts.' And many did. Luna: But does it actually work in a measurable way? I remember an IMF working paper from 2023 that looked at emerging economies during currency crises. They found moral suasion altered bank lending by about 3 to 5 percent. Not huge, but not nothing. Lucas: That paper — I think it was by Bordo and something — they looked at cases where central banks asked banks not to pull credit during a panic. And the effect was statistically significant for the first few months. Then it faded. Because once the crisis becomes acute, moral suasion without a backstop is just words. Luna: Which brings us to the limits. If the market senses that the central bank is just jawboning without any credibility — like if they ask banks to buy government debt during a fiscal crisis — it can backfire. Banks might actually flee faster, worried about being seen as coerced. Lucas: There's a famous negative example: the Bank of England in the 1990s trying to prop up the pound by asking banks not to short it. Banks nodded politely and then shorted it anyway on the way to Black Wednesday. Moral suasion failed because the BoE had already lost credibility. Luna: So the precondition is a credible threat. The central bank needs to have some other tool — regulation, supervision, access to liquidity — that it can actually use if the bank doesn't comply. Otherwise it's just a letter to Santa. Lucas: Exactly. And that's why moral suasion works better in concentrated banking systems. If you have four big banks, one phone call covers 80 percent of the market. If you have four thousand small banks, you're sending a lot of letters. Luna: The Euro area is a good test. The ECB has a lot of moral suasion power over large banks, but smaller national central banks — like the Bank of Greece — can use it effectively because they know the local players. There's a cultural dimension. Lucas: Absolutely. In Japan, the culture of consensus and group harmony makes moral suasion more effective. In the US, where banks are more adversarial and legally aggressive, the Fed uses it less — they prefer to just regulate or adjust the discount window. Luna: But the Fed does use it in crisis. In 2008, Tim Geithner — then at the New York Fed — made a lot of phone calls to bank CEOs to get them to accept TARP money. Some didn't want the stigma, but he leaned on them. Lucas: Right — and that's a case where moral suasion was backed by a very credible threat: if you don't take the capital, we might let you fail. So the suasion was more like persuasion with a gun in the drawer. But in normal times, the gun stays hidden. Luna: What about the flip side? Banks can also use moral suasion on central banks. During the 2023 regional banking stress in the US, smaller banks lobbied the Fed aggressively to pause rate hikes. That's a form of reverse suasion. Lucas: It is. And the Fed did pause — but not purely because of banks. Still, it shows the relationship is two-way. Central banks need cooperation from banks to transmit policy, so they can't just dictate. Luna: I think the key insight is that moral suasion is most powerful when it's never actually mentioned. The moment you say 'I'm using moral suasion,' you've lost it. It has to be implicit. Lucas: That's the governance principle. The Bank of England governor's eyebrow only worked because no one ever said 'that's a threat.' It was a knowing nod. And that's what makes it hard to study — you can't quantify a nod. Luna: But you can see its effects in the data. When the Bank of Japan made those calls, regional bank JGB holdings did decline. Not by a lot, but the trend reversed. That's a signal. Lucas: So the question going forward is whether moral suasion survives the digital age. When central bank communication is all about transparency — publishing minutes, giving press conferences — the quiet off-the-record call feels almost illegitimate. Luna: But that's exactly why it persists. Because formal communication is too slow, too public. Sometimes you need to say something that can't be on the record. Especially during a fast-moving crisis. Lucas: And that's the tension. Central banks want to be transparent, but they also want to be effective. Moral suasion is the shadow tool — it works best when it's not in the spotlight. And as long as human relationships matter in finance, it's not going away. Luna: So next time you hear a central banker say they 'expressed concern' about something — that's probably code for a phone call that happened last week. Lucas: Exactly. And that call might have moved more money than any press release they put out that day.