IS THE CASE FOR CENTRAL BANK INDEPENDENCE DEAD? ED BALLS AND ANNA STANSBURY DISCUSSED BY LAWRENCE SUMMERS AND ADAM POSEN PETERSON INSTITUTE FOR INTERNATIONAL ECONOMICS WASHINGTON, DC APRIL 23, 2018
ALESINA & SUMMERS: THE 1990S CASE FOR INDEPENDENCE Source: Alesina and Summers (1993) 2
SINCE THE 1980S, MOST COUNTRIES INCREASED CENTRAL BANK INDEPENDENCE CBI over time (advanced economies) 1980s JPN NZL USA CAN AUS DNK GBR NOR CHE SWE EUR 2003 Source: Balls, Howat and Stansbury (2018). CBI data from Grilli, Masciandaro and Tabellini (1991) and Arnone, Laurens, Segalotto and Sommer (2007) Euro area data point for 1980s is weighted average of the 1980s CBI of the 2003 Euro member states 3
BUT THE INFLATION-INDEPENDENCE CORRELATION DISAPPEARED PRE-CRISIS Inflation and Central Bank Independence, 2000-2008 Average annual inflation, 2000-2008 0 1 2 3 4 ISR NZL JPN AUS KOR CAN GBR USA DNK NOR EUR SWE Central Bank Independence 2003, GMT measure CHE Source: Balls, Howat and Stansbury (2018). CBI data from Arnone, Laurens, Segalotto and Sommer (2007); inflation data from World Bank WDI 4
WHAT HAS CHANGED SINCE THE FINANCIAL CRISIS? Pre-crisis: Consensus that central bank independence a good thing Build-up of financial sector risks Low and stable inflation Post-crisis: Consensus around central bank independence under pressure New macroprudential responsibilities, tools and structures Too-low inflation and zero lower bound 5
PUBLIC AND POLITICAL CRITICISM 6
ACADEMIC CRITICISM: 1/ POSEN CRITIQUE The impact of central bank independence on economic outcomes is highly overrated...it s not to say central bank independence wasn t important but it took place against this background of a common effort across all central bankers to bring down inflation Central bank independence was as much a reflection of the effort and the credibility gained as a cause. Adam Posen (2017). Speech at Bank of England 20 years on conference. 7
ACADEMIC CRITICISM: 2/ ALESINA CRITIQUE One argument put forward by Fischer and Debelle (1994) is that the policy goal, say the target level of inflation, should be chosen by elected politicians, while the Central Bank should have the independence of choosing the policy instruments more appropriate to achieve that goal This is a rather "minimalist" view of the meaning of Central Bank independence Alberto Alesina and Andrea Stella (2011). The Politics of Monetary Policy. Handbook of Monetary Economics 8
ACADEMIC CRITICISM: 3/ BUITER CRITIQUE Central banks in most of the advanced economies have become too powerful In particular, they have accrued a host of deeply political responsibilities and powers. They have neither the legitimacy nor the capability or skills to discharge all these responsibilities effectively. I propose a return to narrow central banking. Willem Buiter (2014). Central Banks: Powerful, Political, and Unaccountable? Journal of the British Academy 9
ACADEMIC CRITICISM: 4/ SUMMERS CRITIQUE When the primary policy challenge for central banks was establishing credibility that the printing press was under control, it was appropriate for them to jealously guard their independence. When the challenge is to accelerate, rather than brake, economies, more cooperation with domestic fiscal authorities and foreign counterparts is necessary Lawrence Summers (2016). The Age of Secular Stagnation, Foreign Affairs 10
OUR RESEARCH HIGHLIGHTS TWO IMPORTANT DIMENSIONS TO CBI Operational independence: the ability of the central bank to select and use monetary tools with autonomy Political independence: the absence of possibility for political influence over the central bank e.g. Bank of England is operationally independent but not politically independent government sets inflation target ECB and Fed are both operationally and politically independent 11
ADVANCED ECONOMIES INCREASED OPERATIONAL CBI (BUT NOT POLITICAL) 1980s Operational Independence over time JPN CAN NZL AUS USA CHE GBR EUR DNK SWE NOR 1980s JPN AUS NZL Political Independence over time CAN GBR DNK USA NOR CHE SWE EUR 2003 2003 Source: Balls, Howat and Stansbury (2018). CBI data from Grilli, Masciandaro and Tabellini (1991) and Arnone, Laurens, Segalotto and Sommer (2007) Euro area data point for 1980s is weighted average of the 1980s CBI of the 2003 Euro member states 12
ONLY OPERATIONAL CBI MATTERED FOR ADVANCED ECONOMIES IN 1970S/80S Average annual inflation, 1980s -5 0 5 10 Inflation and Operational Independence, 1980s (AVPlot) NOR FIN ITA LUX GRC ESP PRT SWE DNK JPN FRA NZL DEU USA IRL NLD CHE AUS GBR CAN -.6 -.4 -.2 0.2.4 Operational Independence 1980s coef = -6.067239, se = 2.7798183, t = -2.18 BEL AUT Average annual inflation, 1980s -5 0 5 10 Inflation and Political Independence, 1980s (AVPlot) JPN NZL GBR BEL AUS DNK SWE LUX FRA AUT CAN FIN GRC NOR CHE PRT IRL ESP USA ITA DEU NLD -.4 -.2 0.2.4 Political Independence 1980s coef =.83703529, se = 3.8915158, t =.22 contrary to the Alesina critique 13
AND BY 2000S THEY ALL HAD HIGH OPERATIONAL CBI AND LOW INFLATION Inflation and Operational Independence, 1980s and 2000s Average inflation 0 5 10 15 20 FIN ITA NOR LUX GRC PRT ESP SWE NZL FRA DNK IRL BEL AUT NLD JPN JPN GBR CAN CHE KOR ISR CAN NZL AUS USA DEU USA AUS NOR GBR DNK EUR SWE CHE Operational Independence 1980s, fitted values 1980s 2000s suggesting that notwithstanding the Posen critique the 1980s/1990s case for operational independence remains 14
BUT CRISIS HAS GIVEN CENTRAL BANKS ADDITIONAL POWERS AND CHALLENGES Macro-prudential policy Can central banks manage these extra powers and responsibilities? Or is this an area central banks should withdraw from? (Buiter) Monetary-fiscal coordination Does central bank independence make this impossible? (Summers) 15
CRITERIA FOR REFORM: WHEN DOES INDEPENDENCE MAKE SENSE? When should a policy function be located in an independent institution? Political incentive to cheat Clearly-defined goal and effective accountability mechanism No first-order distributional impact No significant fiscal impact When should that institution be the central bank? No conflict with monetary policy Relevant expertise in the central bank 16
MONETARY POLICY When should a policy function be located in an independent institution? Political incentive to cheat Clearly-defined goal and effective accountability mechanism No first-order distributional impact No significant fiscal impact When should that institution be the central bank? No conflict with monetary policy Relevant expertise in the central bank 17
SYSTEMIC RISK OVERSIGHT AND MACRO- PRUDENTIAL POLICY When should a policy function be located in an independent institution? Political incentive to cheat Clearly-defined goal and effective accountability mechanism No first-order distributional impact No significant fiscal impact When should that institution be the central bank? No conflict with monetary policy Relevant expertise in the central bank 18
IS BUITER RIGHT THAT CENTRAL BANKS SHOULD GET OUT OF MACROPRUDENTIAL POLICY? Macro-prudential policy and systemic risk management is clearly a risk for both the credibility of central bank independence and democratic accountability Hard to define a clear goal First order distributional impact Risk of significant fiscal impact Potential conflict with monetary policy But in our paper we argue that operational independence can help provide a solution 19
OUR SOLUTION FOR MACRO-PRUDENTIAL POLICY Separate systemic risk oversight and macro-prudential policy. A systemic risk oversight body should: Be responsible for monitoring systemic risks and setting policy priorities Include members from the central bank, regulators and the government Be chaired by a government representative A macro-prudential body should: Be operationally independent from government Bring together central bank and financial regulators Be led by the central bank Argues for a hybrid model between current Fed and Bank of England 20
MONETARY-FISCAL POLICY COORDINATION When should a policy function be located in an independent institution? Political incentive to cheat Clearly-defined goal and effective accountability mechanism No first-order distributional impact No significant fiscal impact When should that institution be the central bank? No conflict with monetary policy Relevant expertise in the central bank 21 21
IS SUMMERS RIGHT THAT MONETARY-FISCAL COORDINATION AND CBI CONFLICT? Lack of monetary-fiscal coordination was clearly a big problem post-crisis Fiscal policymakers, far from helping the economy, appeared to be actively working to hinder it Monetary policy cannot carry the entire burden Ben Bernanke (2015) A stronger collective policy approach is urgently needed, focusing on a greater use of fiscal and pro-growth structural policies, to strengthen growth and reduce financial risks Catherine Mann, OECD Chief Economist (2016) It is essential that fiscal policy supports the nascent recovery. Planned nearterm fiscal tightening will be a drag on growth IMF (2013) United Kingdom Article IV Consultation In our paper we explore whether operational independence can help find a solution 22
ONE POSSIBLE SOLUTION FOR MONETARY-FISCAL COORDINATION One possible solution could be a fiscal open letter system Once the interest rate goes below a pre-defined threshold close to the ZLB, the central bank writes a quarterly open letter to the government, with its view on the appropriate stance of fiscal policy to help meet the inflation target (and support growth) This would meet three conditions: Decision to send letter triggered by the central bank Ability to send letter confined to the zero lower bound Government retains control over stance and content of fiscal policy But still a risk that central bank may be drawn into politics? 23
CONCLUDING REMARKS The case for operational independence is not dead (if it was ever alive Adam?) But since the financial crisis independent central banks have become more unpopular as their powers and responsibilities have increased. Our paper argues that the solution must strike the right balance between operational independence and effective political oversight. No country has it right yet on macroprudential policy: the U.S. and U.K. can learn from each other 24
APPENDIX SLIDES 25
CENTRAL BANK INDEPENDENCE OVER TIME IN EMERGING ECONOMIES CBI over time (emerging economies) 1980s QAT ZAF BHS EGY HND LBN NIC UGA KEN ZWE ETH TZA THA NGA IND ZMB MYS CHN BRB GHA ISR BWA COL SGP PAN MAR PAK KOR NPL CRI PER TUR PHL MLT ARG BOL MEX ISL ROM IDN VEN CHL BRA SRB SVN URY HUN POL HRV BIH MKD 2003 26
POLITICAL AND OPERATIONAL INDEPENDENCE OVER TIME IN EMERGING ECONOMIES 1980s HND NIC EGY BWA KEN TZA BRB QAT LBN COL ZWE ISR Political Independence over time PER CHN ETH ZMB CRI ISL MLT MEX TUR ROM BOL PAN THA BRA PHL UGA VEN ARG MAR IND ZAF NGA GHA NPL PAK SGP CHL IDN URY HUN POL MYS 2003 No IMF program 1993-2002 IMF program 1993-2002 1980s PAN Operational Independence over time QAT THA SGP ZAF ZWE IND ZMB EGY NGA MYS BWA LBN UGA ETHPHL KEN TZA GHA BRB MAR NPL ISR MEX PAK URY ARGPER NIC CRI HND TUR HUN COL CHN BOL MLT IDN CHL POL ROM ISL VEN 2003 No IMF program 1993-2002 IMF program 1993-2002 BRA 27