Adding “realism and a degree of modesty” to monetary policy framework?

Reserve Bank of Australia chief Glenn Stevens in a speech says:

Had anyone, a decade ago, accurately forecast all the international events and simultaneously predicted that things would turn out in Australia as they have, they would not have been believed. But here we are.

No doubt many factors were at work in achieving this. The economy’s inherent ability to adapt has been considerably better than in past episodes of large shocks. I think that is a tribute to various reforms over earlier years and the better management of many individual enterprises.

Policy frameworks functioned effectively. The exchange rate responded to the external shocks in the way it is supposed to. Prudential supervision was effective. The managements of the most important financial institutions managed to avoid being caught up in a major way in the things that brought so much grief to their counterparts elsewhere in the world. Fiscal policy played a major countercyclical role in the most acute phase of the international downturn (though how much latitude it would have to do that again, if needed, is less clear).

And as you would expect, I think that the monetary policy framework has functioned very well. The operation of that framework has involved:

  • an independent central bank focusing on the medium-term inflation target, taking account of the state of the real economy and the shocks affecting it;
  • neither neglecting financial stability considerations nor letting them completely dictate monetary policy;
  • allowing the floating exchange rate to adjust; and, importantly,
  • realism and a degree of modesty, about what monetary policy can achieve.

I think it can be said that, operating this framework and under the guidance of the Board, the Bank has delivered on its mandate through difficult times.

It is interesting to see” realism and a degree of modesty, about what monetary policy can achieve” becoming part of the framework! When did this happen?

Friedman had long ago lectured on limits of monetary policy and central banking but advice was ignored. Both central bankers and financial markets have gone completely amok in making people believe that central banks are this place of almighty.

Loads of hubris and overconfidence has been the hallmark of central bankers for a while now. They have continued to reinforce the belief that they have a solution for all ills facing an economy. Their over the top statements continue to drive the markets. In the name of central bank independence, they have taken the role of public intellectuals and lecture on everything under the sun taking the almighty tag a bit too seriously.

It is not just about being modest abut what monetary policy can achieve. It is more important that people who run the central banks show the same modesty as well. After all they are the ones who are supposed to take this very message to public. You cannot have a situation where you talk about limits of monetary policy but at the same time central bankers believing they can do anything under the illusion of overconfidence…

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