How to design a new Central Bank?

Ricardo Reis of Columbia explores the issue in the NBER conference on 100 Years of Fed.

He begins asking the q what is one had to design a new Fed:

Starting from a blank page, how could one design the institutions of a central bank for the United States? This paper examines what the relevant economic literature and the experiences of the past reveal about this question, unencumbered by the history of how the Fed got to what it is today or by the short-term political constraints it faced. The perspective is akin to setting up a mechanism design problem, but falling well short of a speci c formalization and rather discussing what its main ingredients might look like. The goal is to investigate the trade-o s associated with di erent choices and to identify areas where there are clear messages about optimal central bank design.

This question is not as outlandish as it may seem. As soon as the Iraq war ended in 2003,the  fi rst major issue that Coalition economists confronted: What should be done with the Iraqi dinar?” (Foote et al., 2004, page 60) The economists involved stated that adopting a new central bank law in March 2004 was one of their rst and most important economicaccomplishments, and this is true in most transition countries as well. Even looking at developed countries, just 20 years ago, Europeans had to come up with an answer to this question after they signed the Maastricht Treaty (von Hagen, 1997). The Federal Reserve has also not been an institution set in stone; slowly, and with turns in di erent directions, its structure has been molded over 100 years into what it is today.2 My goal here is not to describe these historical developments but rather to try to survey the economic literature on the trade-o s involved in designing a central bank for the United States.

He says there are 12 principles on c-bank design:

This paper summarizes the relevant economic literature that bears on twelve principles in centralbank design:
(i) the strictness of the banks’ mandate;
(ii) the choice of long-run goals;
(iii) the potential role of short-term goals;

(iv) the choice of central banker(s);
(v) therole of the central bank as a source of revenue;
(vi) the importance of having fiscal backing;
(vii) the set of assets held by the central bank;
(viii) the payment of interest on reserves;
(ix) the importance of announcements and commitment to future actions;
(x) choosing the amount of transparency;
(xi) picking the channel(s) of communication;
(xii) the accountability of the central bank.

In terms of economese:

Stripped to its core, a central bank is the sole institution in a country with the power to issue banknotes to the public and borrow from banks in the form of reserves that trade on par with currency. More broadly, the central bank can choose some policy instruments that it controls directly, as well as a set of announcements about its knowledge of the economy or future policy intentions. Designing the central bank then consists of specifying three objects.

First is the objective function, which comes from somewhere or someone, and includes only a few macroeconomic variables, potentially at di erent horizons. Second, the central bank faces a resource constraint, limiting both its ability to distribute dividends as well as the set of policies that it can pursue. Third is the set of equilibrium constraints mapping policy actions and announcements into the simultaneous evolution of private agents’ beliefs and macroeconomic outcomes. In Ramsey problems, these would be called the implementability constraints”. Implicit in them is a notion of equilibrium, and because they depend on agents’ beliefs, commitments by the central bank or transparency about its future intentions have a direct on outcomes today.

 

Broader message is:

The broader message of this paper is that designing a central bank is not just a worthwhile research question, but also one that can be answered scienti cally. There is much research that can be brought to bear on the topic, so we need not resort to hunches, old aphorisms, or vague platitudes. Diverse tools and models, drawn from di fferent branches of economics, can come together in informing this particular application of mechanism design.

Super read,,

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