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The Global Battle Over Central Bank Independence James Bullard President and CEO, FRB-St. Louis 4 January 2013 NABE Panel Discussion: “Federal Reserve Independence in the Aftermath of the Financial Crisis: Should We Be Worried?” AEA/ASSA Annual Meeting San Diego, California Any opinions expressed here are my own and do not necessarily reflect those of others on the Federal Open Market Committee. This talk o o Financial crisis aftershocks have partially broken down the consensus on the wisdom of central bank independence. To the extent that central bank independence is weakened globally, macroeconomic stabilization policy will not be executed as well in the future as it has been since the mid1980s. o This suggests more macroeconomic volatility ahead. o “Fiscalization” of monetary policy will tend to complicate the policymaking process substantially. o Live example: The ECB’s OMT program. Consensus Weakening What is the consensus on central bank independence? o o o o Effective macroeconomic stabilization policy has to be implemented in a timely manner in reaction to macroeconomic shocks. Example: Taylor-type policy rules. Fiscal policy adjustments through tax, spending, and borrowing policy tend to be slow and must be carefully negotiated. Monetary policy can be implemented in a timely and technocratic manner. Hence the conventional wisdom: o Focus fiscal policy decisions on the medium and longer run. o Delegate monetary policy to an independent authority. Why is this the consensus? o o o The goal is to have an effective macroeconomic stabilization policy. If monetary policy is not delegated to an independent authority, then it too becomes part of the slow and complicated negotiations associated with fiscal policy. The society would be left without a way to make timely policy adjustments in reaction to macroeconomic shocks. o The result would be more macroeconomic volatility. o The consensus therefore suggests that macroeconomic outcomes will be better with an independent central bank. Why is the consensus breaking down? o The central banks in the G-7 encountered the zero lower bound on nominal interest rates. o This led many to talk about the need for fiscal authorities to step up and conduct macroeconomic stabilization policy. o However, the usual political hurdles asserted themselves and led to a hodgepodge of fiscal policy responses not particularly well-timed with macroeconomic events. Policy rates Source: Haver Analytics. Last observation: November 2012. Aside: The zero lower bound and fiscal programs o The binding ZLB does not necessarily imply a need for fiscally-oriented macroeconomic stabilization policy. o Central banks have conducted stabilization policy effectively even while at the zero bound. o Two key tools: QE programs and forward guidance. o Evidence: Inflation has generally stayed near target instead of falling dramatically. o The NK literature suggests that an effective monetary policy makes fiscal stabilization policy irrelevant, and that forward guidance keeps monetary policy effective even at the ZLB.* * See: J. Bullard, 2012, “Death of a Theory,” FRB of St. Louis Review, March/April, 94(2), pp. 83-102. Fiscal Responses The central bank and fiscal policy o Nevertheless, many see fiscal stabilization policy as desirable in the current context. o One idea: Suggest that the central bank take actions that are cumbersome to accomplish through a democratically-elected body. o This may be seen as one way to get the relatively speedy monetary policy decision-making into a fiscal policy context. Slower, Negotiated Decision-Making o This is a “creeping politicization” of monetary policy. o Some central bank independence is lost since the monetary authority is taking actions at the behest of other policy actors. o Monetary policy decisions then become wrapped up with fiscal policy decisions, slowing down the process through negotiation and making it considerably more complicated. A proper approach o o o o Why ask a central bank to design programs outside of its area of expertise? Democratically-elected institutions could certainly create a fiscal stabilization authority, perhaps modeled on the FOMC, that could make technocratic fiscal decisions in speedy reaction to macroeconomic events. Such an authority could be allowed to act within assigned limits and under a clearly-specified mandate with periodic reporting. I have never heard of such a proposal, but Congress clearly does create specific institutions for specific purposes. Outright Monetary Transactions The recent ECB program o o o o o The European Central Bank recently announced an “outright monetary transactions” (OMT) program. This program has been widely interpreted as a promise to buy the sovereign debt of individual nations. A key element of the program is that purchases, should they occur, are conditional on the nation meeting certain fiscal targets. Purchases would be sterilized, so that the program is not the same as U.S.- and U.K.-style quantitative easing. The program has been regarded as “successful” so far. Euro area 10-year bond spreads Source: Financial Times and author’s calculations. Last observation: week of December 28, 2012. Euro area 5-year sovereign CDS’s spreads Source: Bloomberg and author’s calculations. Last observation: January 2, 2013. Fiscalization of monetary policy o This is “fiscalization” of monetary policy: Asking the central bank to take actions far outside the remit of monetary policy. o The analog in the U.S. would be a promise to purchase, or even monetize, state debt in exchange for the state maintaining a fiscal program considered prudent by the central bank. o o Assistance like this from a central authority to a region is best brokered through the political process in democraticallyelected bodies. In Europe, the ECB is in essence substituting for a weak panEuropean central government. Ordinary monetary policy o o o Ordinary monetary policy provides or removes monetary accommodation in response to macroeconomic developments. There has been a large macroeconomic development in Europe: Eurozone recession. Yet, little direct action has been taken by the ECB in response to the recession. o The policy rate has not been significantly adjusted. o The ECB has not employed QE or used forward guidance. A muted response o One could argue that the monetary policy response to the European recession has been muted compared to more ordinary circumstances. o Why? By nearly all accounts, the monetary policy process has been bogged down by political wrangling over the OMT and other programs. Ordinary monetary policy derailed o End result: o By conducting a fiscal action, the central bank has been pulled away from its ordinary macroeconomic stabilization policy. o Standard monetary policy has become wrapped up in the fiscal policy package and subject to the negotiations that surround that package. o This defeats one of the original purposes of central bank independence: Having a monetary authority that can react to macroeconomic shocks quickly and effectively. Conclusions Summary o o o o o Financial crisis aftershocks have introduced a “creeping politicization” of central banking globally. The macroeconomic performance of nations with politicized central banks has historically been quite poor. One live example of the current trend is the ECB’s OMT program. One interpretation of the OMT is that it is a fiscal-type operation, and that ordinary monetary policy has become part of the negotiation over the fiscal package. This has altered the response of the ECB to the European recession. Federal Reserve Bank of St. Louis stlouisfed.org Federal Reserve Economic Data (FRED) research.stlouisfed.org/fred2/ James Bullard research.stlouisfed.org/econ/bullard/