Tuesday, September 20, 2011

Rethinking Central Banking (ls)

Eichengreen, Rajan, Rodrik, di Mauro, Shin, Rogoff and other leading economists have released a brillant report on the future of Central Banking. The report can be downloaded here, a summary can be found on vox.

They especially focus on the debate of whether central banks should pursue a financial stability goal. They reach a conclusion which I fully share. Here are their key points (my emphasis, originally taken from the vox summary):

It is time to move beyond dissatisfaction with the prevailing framework and properly flesh out an alternative. In our view [...] that alternative should have the following elements:
  • Financial stability should be an explicit mandate of central banks.
Other micro- and macroprudential policies should be deployed first, wherever possible, in the pursuit of financial stability, but monetary policy should be regarded a legitimate part of the macroprudential supervisors’ toolkit.
  • When rapid credit growth or other indicators of financial excess accompany asset price increases, the authorities should employ stress tests to measure the effects of changes in credit conditions on asset prices, economic activity, and financial stability.
Instead of seeking to identify bubbles, the authorities should simply ask whether current financing conditions are raising the likelihood of sharp reversals in asset prices that are disruptive to economic activity.
  • Where the answer to the aforementioned question is yes, central bankers should then lean against the wind using a combination of the tools at their disposal, turning first to non-monetary micro- and macroprudential tools, but also to monetary policy tools when necessary.
If this results in periods when, in the interests of financial stability, the central bank sets policies that could result in deviations from its inflation target, then so be it.
  • Responsibility for the maintenance of financial stability can be assigned either to the central bank or to a self-standing financial supervisory authority. But in both setups, close coordination between the central bank and other agencies that contribute to ensuring the stability of financial conditions is essential.
This is particularly important when policymakers have to evaluate the tradeoffs between the use of monetary tools and prudential measures and make decisions on the appropriate mix.
  • Central banks already require substantial operational independence in order to pursue their mandates. They will require even greater independence when a financial-stability objective is added to those mandates.
They will, in turn, have to establish the legitimacy of their actions in circumstances where the nature of threats to financial stability is poorly understood.
[...] Independence is politically viable only with accountability, and the best way to enhance accountability is for central banks to become more transparent and forthright about their objectives and tactics.
  • The spillover effects of a central bank’s policies in other countries are a legitimate concern.
At present, central banks do little to internalise these effects. Admittedly, they may have difficulty in justifying actions taken in the effort to do so to domestic political authorities.
This tension points to the need for further changes in prevailing policy framework. Specifically, domestic political authorities should be persuaded to allow such considerations to play an explicit role in the central bank’s monetary policy framework in large economies. Large-country central banks should pay more attention to their collective policy stance and its global implications. Where appropriate, they should consider coordinated action to help stabilise the global economy in times of stress.