I was intrigued by Munchau’s editorial on central bank independence, that appeared on today’s FT. Munchau argues that central banks’ choices are increasingly political in nature, especially if their mandate is broad, as is the case for example of the Fed. His argument is that a broad mandate implies tradeoffs, and as such it does not go well with central bank independence.
I must say I am unconvinced to say the least, on at least two levels.
First, I do not see how a strict mandate would make central bank choices less political in nature. It makes them more opaque, but by no means less political. I wrote about this in a paper on ECB action during the crisis, and more succinctly in an op-ed for Social Europe co-written with Yan Islam back in 2015. Let me quote a few excerpts from that piece:
A dual mandate requiring the central bank to pursue two, sometimes conflicting, objectives forces the institution to make inherently political choices. Far from being a shortcoming, this allows for a more flexible and unbiased monetary policy. A central bank following a dual mandate will always be able to take an aggressive stance on inflation, if it deems this necessary. Appropriate choice of the weights given to employment and inflation would allow incorporation of any combination of the two objectives. […]
Inflation-targeting central banks, such as the ECB, de facto also target growth but timidly and without explicitly saying so. This leads to low reactivity and opaque communication, hampering in turn the capacity of central banks to manage expectations and effectively steer the economy. A good case in point is the ECB that – compared to the Fed – did “too little and too late” from 2009, amid a constant debate on whether the inflation-targeting mandate was being violated. […]
ECB opacity is intrinsically linked to the confusion between its mandate and its activities in the real world, and as such it cannot lead to any meaningful discussion but only to legalistic disputes on the definition of price stability, of how medium is the medium term and the like.
The main merit of a dual mandate is in fact that it lets the political nature of monetary policy emerge without ambiguities. It is indeed true that monetary policy with a dual mandate requires hard choices, just like those debated these days, and hence is political by its very nature. The point is, so is monetary policy with a simple inflation-targeting objective. The level of inflation targeted, and the choice of the instruments to attain it, is anything but neutral in terms of its consequences on the economy. Thus, an inflation-targeting central bank is as political in its actions as a bank following a dual mandate, the only difference being that In the former case the political nature of monetary policy is concealed behind a technocratic curtain.
In a sentence, we argued that monetary policy choices are always political, and as such they should be incorporated in the policy mix, without hiding behind what Yan and I called a technocratic illusion.
Munchau’s link between the broadness of the mandate and its political nature, is simplistic and in my opinion strongly misleading. In fact, we concluded back in 2015 that it is linked to a specific intellectual framework
The profound justification of an exclusive focus on price stability can only lie in the acceptance of a neoclassical view in which virtually powerless governments need to make little or no choices. Once we dismiss that platonic view, monetary policy acquires a political role, regardless of the mandate it is given.
The second reason why Munchau’s argument is unconvincing is the conclusion, somewhat implicit in his piece, that a central bank making political choices needs to be a “government agency”. Why is it so, exactly? I fail to see it. What matters is not that the central bank is controlled by the finance ministry, but that it is accountable, like any other actor doing policy, in a system of well functioning checks and balances.
Once we recognize that a central bank has a political role, we need to make sure first, that its mandate is not falsely perceived as technocratic; and second, that its actions are properly embedded in a balanced policy mix, in which there is coordination with, not subordination to, the other branches of government. It seems to me that the US institutional system comes pretty close to this. The same cannot be said for the eurozone.
Life and work keep having the nasty habit of intruding into this blog, but it feels nice to resume writing, even if just with a short comment.
We learned a few weeks ago that the Bank of Japan has walked one extra step in its attempt to escape lowflation, and that it has committed to overshoot its 2% inflation target. A “credible promise to be irresponsible”, as the FT says quoting Paul Krugman.
This may be a long overdue first step towards a revision of the inflation target, as invoked long ago by Olivier Blanchard, and more recently by Larry Ball. This is all too reasonable: if the equilibrium interest rates are negative, if monetary policy is bound by the zero-or-only-slightly-negative-lower-bound, higher inflation targets would make sense, and 4% is an arbitrary target as legitimate as the current also arbitrary 2% level. Things may be moving, as the subject was evoked, if not discussed, at the recent Central Bankers gathering in Jackson Hole. We’ll see if anything comes out of this.
But the FT also adds an interesting comment to the BoJ move, namely that the more serious risk is a blow to credibility. If it failed to lift the inflation to the 2% target, how can it be credibly believed to overshoot it?
This is a different sort of credibility issue, much more reasonable indeed, than the one we have been used to in the past three decades, linked to the concept of dynamic inconsistency. In plain English the idea that an actor has no incentive to keep prior commitments that go against its own interest, and hence deviates from the initial plan. Credibility was therefore associated to changing incentives over time (typically for policy makers), and invoked to recommend rules over discretion.
Today, eight years into the zero lower bound, we go back to a more intuitive definition of credibility: announcing an objective and not being able to attain it.
The difference between the two definitions of credibility is not anodyne. In the first case, the unwillingness of central banks to behave appropriately can be corrected through the adoption of constraining rules. In the latter, the central bank cannot attain the objective regardless of incentives and constraints, and other strategies need to be put in place.
The other strategy, the reader will not be surprised to learn, is fiscal policy. Monetary dominance is in fact a second tenet of the Consensus from the 1990s that the crisis has wiped out. We used to live in a world in which structural reforms would take care of increasing potential growth, monetary policy would be used to take care of (minor) demand-driven fluctuations, and fiscal policy was in a closet.
This is gone (luckily). Even the large policy making institutions now call for a comprehensive and multi-instrument policy making. The policy mix, a central element of macroeconomics in the pre-rational expectations era, is now back. Even the granitic dichotomy between short (demand driven) and long (supply driven) term, is somewhat rediscussed.
The excessively simplified consensus that dominated macroeconomics for the past thirty years seems to be seriously in trouble; complexity, tradeoffs, coordination, are now the issues discussed in academia and in policy circles. This is good news.
I am puzzled by Wolfgang Münchau’s latest piece in the Financial Times. Let me start by quoting the end:
[…] The ECB should have started large-scale asset purchase a year ago. It certainly should do so now. The EU should allow governments to overshoot their deficit targets this year, and suspend the fiscal compact, which will result in further fiscal pain from 2016.
Even a casual reader of this blog will quickly realize that it would be hard for me to agree more with these statements. The macroeconomic stance at the EMU level has been seriously inappropriate since 2010, with fiscal policy globally restrictive (thank you austerity), and monetary policy way too timid.
So, what is the problem? The problem is the first part of Münchau’s editorial, in which he attacks the Bundesbank for its plea in favour of faster wage growth in Germany (the Buba asked for an average wage increase of 3%).
This is frankly hard to understand. The eurozone problems, and it’s flirting with deflation, stem from the victory of the Berlin View, that laid the burden of adjustment on the shoulders of peripheral countries alone.
The call for wage increases in Germany signals, and it was about time, that even conservative German institutions are beginning to realize the obvious: there will be no rebalancing, and therefore no robust recovery, unless German domestic demand recovers. This means a fiscal expansion, as well as private expenditure recovery. Unsurprisingly, the Buba rules out the former, but it is nice to see that at least the latter has become an objective. Faster wage growth may not make a huge difference in quantitative terms, but it still marks an important change of attitude. This is a huge step away from the low-wage-high-productivity-export-led model that the Bundesbank and the German government have been preaching (and imposing to their partners).
Münchau is right in calling for a different policy mix in the EMU. But this is complementary, not alternative, to a change in the German growth model. I would have expected him to applaud a small but potentially important change in attitude. Instead I have read a virulent attack. Puzzled, puzzled…