This is the title of a speech by Otmar Issing, ECB’s first chief economist. The speech is Annual Mayakawa Lecture organised by BoJ.
Issing provides a nice overview of how mon pol and central banking has evolved over the years:
I will begin my lecture giving a short description of how the reputation of central banks evolved over time (with the relief from administrative measures, the acknowledgement of the rational expectations theory and the focus on a clear, single mandate of price stability being milestones).
I will then discuss the concept of Inflation Targeting in Section 2 and (– although central banks around the world seem to have reached a consensus being the optimal monetary policy –) I will make the case that IT is based on shaky grounds.Considerable flaws characterize also the Jackson Hole consensus, with the unfolding of the financial crisis being only the most recent and prominent manifestation of those flaws.
In Section 3, I will explain the lessons to be drawn from that experience. While the close monitoring of money and credit developments is one of these lessons, it does, however, not imply the extension of the central bank’s mandate to financial stability (as other, even more important tools – such as regulation and supervision – lie beyond the monetary policy sphere). After saying a couple of words concerning the complexity of communication taking time lags and real time data uncertainty into account, I will stress the point of not challenging central banks’ reputation even further by imposing tasks upon them for which they have no competence.
Just like his other speeches he criticises CBs for not using monetary aggregates (money supply, credit) in their mon policy. Tracking the latter also helps understand the developments in financial markets. Loads of research post-crisis shows that credit growth is perhaps the simplest and most important indicator for tracking financial stability. Any deviation of credit growth from long term average shows fin instability is building in.
However, this is something I never really understand of ECB and ex-ECB officials. ECB has been following the monetary numbers (so called mon pillar) since its inception. But even its track record on financial stability is anything but great. This is not to lower the role of monetary aggregates but request ECB officials to give more understanding on the linkages.
In Bundesbank style, he dismisses the need for higher inflation target and says C-Banks should stick to their core area of price stability. For financial stability they should look at mon aggregates.
He says lender of last resort should be given only at higher rates against good collateral. This puts central banks in a dilemma. Even G-secs are not seen as risk free anymore in these times. What can be called a good collateral in these times?
Plenty of things to figure for C-banks in this crisis:
Confronted with these requests from politics and the financial industry, supported strongly by seemingly attractive concepts developed by academics, central banks are in an extremely difficult position. Following these ideas would ruin their credibility and reputation as defenders of the value of money. It does not pay credit to the economic profession that a number of proponents openly argue in favor of expropriating savers via planned higher inflation without even considering the consequences for society. Should and could central banks participate in such a concept?
Central banks will, however in the short term, be on the loser’s side once they defend independence and their responsibility for maintaining the value of money. This will be the case because they will be blamed for all the negative consequences which will be attributed to them for their resistance to participate in the “coordination game”. In the longer term such firmness might turn out as the best contribution central banks can make for the welfare of society. For that central banks should demonstrate modesty in what they promise to deliver, explain convincingly what they have no competence for, be transparent on their actions, open to discussion, but firm in their determination to preserve the value of money which is the final anchor in a paper standard.
Central bankers in really tough times…
