In search of a robust monetary policy framework

ECB Chief economist Jürgen Stark gives a decent speech on the topic. He reviews the key thoughts on central banking before this crisis and what has changed after the crisis. In the end so typically of all ECB members, he says ECB’s framework is suitable to deal with risks that have emerged from this crisis.

First, what was the pre-crisis consensus? There were 3 broad elements:

  • central bank independence;
  • price stability as the primary objective of central banks; and
  • the importance of transparent communication for the solid anchoring of long-term inflation expectations.

However, consensus also included these and ECB never agreed on them:

  • the targeting of inflation at a relatively short and fixed horizon;
  • the assignment of a primary role to monetary policy in the management of aggregate demand in the short term;
  • the systematic disregard of money and credit indicators in the conduct of monetary policy; and
  • the asymmetric reaction to asset price bubbles as opposed to busts; the latter often referred to as the “cleaning-up strategy” in the context of the “Jackson Hole consensus”.

Certain broad ideas from the pre-crisis consensus are still valid such as central bank independence but others need to change.

He tracks central bank developments to two key events – one setting up of inflation target central banks and two formation of ECB. Where inflation target central banks had above mentioned flaws, ECB tried to iron out these deficiencies. In ECB focus was on managing inflation over a much longer term and not getting into short-term aggregate demand management. And then it persisted  with Bundesbank’s tradition of following monetary aggregates closely.

He then reviews debates around central bankers’ role in financial stability. After covering both pros and cons he shows how monitoring credit and money trends ahs emerged as the most useful leading indicator.

A nice speech covering overall issues in central banking. Though, he praises ECB a way too much. It is a solid central bank  but has found to be wanting in a crisis like this. It has taken decisions based on the union it manages but with much diversity amidst the members, its actions have been highly criticised.

What irks me most is none of the ECB members willing to accept there are problems with the current structure. There is no harm in doing that as nothing is perfect. And this crisis is a great opportunity to work on these problems. But you have to first accept the problem. But nothing from ECB. So much so, Trichet says there was never a crisis and most others prefer to blame the problems to their North Atlantic partner (read US).

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