Does Central Bank Independence Need Inflation Targeting?
Two articles on today’s Financial Times puzzle me. The first (Weidmann warns of currency war risk) offers yet another example of how economic analysis sometimes leaves the way to ideological beliefs. The Bundesbank’s president argues (as he already did in the past) that giving up inflation targeting hampers central bank independence. How? Why? He does not bother explaining.
What I think he has in mind is that once the objective of the central bank goes beyond strict inflation targeting, monetary policy needs an arbitrage between often conflicting objectives (typically unemployment and inflation). It is the essence of the dual mandate. This of course moves monetary policy out of the realm of technocratic choice, and makes it a political institution (Stephen King explains it nicely). I would argue that this is normal once we abandon the ideal-type of frictionless neoclassical economics, and we accept that we may have a tradeoff between inflation and unemployment. But this is not the issue here. The issue, and the puzzle, is why transforming the choice from technocratic to political, should necessarily lead to giving up independence.
There seems to be an inherent confusion in Weidmann, and in many others, between policy coordination and the subjugation of central banks to dreadful, intrinsically vicious governments. To simplify things, central banks cannot, with the monetary instrument alone, reach two objectives (a trivial instrument assignment problem). Thus, monetary policy should be coordinated with fiscal policy in order to obtain both price stability and unemployment reduction. Does this mean that the central bank and the government should be the same? Does it even mean that they should give equal weight to inflation and unemployment? I really cannot see any reason why it should. Abandoning pure inflation targeting would simply imply for central bankers to step off their ivory tower, and engage in joint policy making with the government. This is what happens in the United States, where the Fed and the treasury cooperate and coordinate in order to minimize unemployment and inflation. Sometimes they succeed, sometimes they don’t, but certainly nobody would argue that the Fed is not independent.
The same cannot be said for the Bank of Japan (this is the second puzzling article). While along with many others I welcome the long overdue Keynesian turn of the Japanese government, I am perplex as of the way the BoJ is bullied into changing policies. I would have preferred to see Shinzo Abe endow the BoJ with a sensible objective (be it nominal GDP targeting or the dual mandate), and let it choose independently as of the moment and of the instruments to use. At any rate, the point is, once again, independence has little or nothing to do with the policies followed.
Of course, all of this only makes sense outside the ideal neoclassical world. If we believe that there is no tradeoff, that markets converge spontaneously towards full employment, then there is no need for policy coordination. Unemployment takes care of itself, the central bank needs only to worry about inflation, and fiscal policy vanishes into irrelevancy. But if we believe this, we may as well rely on Santa Claus to lift us out of this crisis…