Scott Sumner  

No hawks or doves, just owls

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Here is Germany's representative at the ECB, Jens Weidmann:

Mr. Weidmann's conservative stance contrasts with the ECB's latest attempts to convince investors that it will act forcefully to boost the flow of money to the economy, and may raise doubts about the bank's ability to gain the consensus to do still more expansive steps if needed. He warned of the danger of relying too much on central banks to solve economic problems.

"There is a risk of monetary policy, especially in the euro area, being held hostage by politics," Mr. Weidmann said in an interview conducted Monday at the Bundesbank in Frankfurt, just a few miles from the ECB.

. . . In sharp contrast, Mr. Weidmann in the interview stressed that the Bundesbank's hard-money, conservative philosophy remains relevant despite repeated financial crises in recent years that prompted central banks around the world to experiment with policies such as asset purchases. "The concept of an independent central bank clearly focused on price stability is neither old-fashioned nor outdated," he said. "It is about not falling into the trap of 'This time is different.' "


At this point you might be yawning. Yes, Weidmann's a hawk, and he's expressing hawkish views. What's so strange about that? OK, but consider that if you take the ECB's inflation mandate seriously, then none of Weidmann's views make any sense. His "hard money, conservative philosophy" is as irrelevant as his religion, or the football team he roots for. Even by just mentioning these views the reporter is implying Weidmann is corrupt. If you take the mandate seriously there should be no hawks and doves. Here is how it is supposed to work:

1. ECB hawks and doves debate the issue of which mandate is best. The hawks argue for a lower inflation target, and the doves argue for a higher inflation target. Then they pick a target, and at that point they all try to achieve a common goal, the actual target they adopted. There would be differences over purely technical issues, such as what instrument setting would be most likely to hit 1.9% inflation (the ECB's target.) But that's all. No one would be consistently hawkish or dovish, at least if their forecasts of future inflation were unbiased. So the fact that people clearly are hawks and doves, suggests that they are either incompetent or corrupt. Add in the fact that the hawk/dove stance is correlated with their views on unrelated issues such as fiscal policy and hard money, and it's pretty clear that the problem is not just incompetence.

2. You might still be yawning. "So political appointees are not pure as the driven snow. They haven't really bought into the official target. What else is new? Don't be so naive."

Yes, I know all that. But here's something you may not know. This corruption would be almost impossible under price level targeting. With inflation targeting you can have central banks like the BOJ pretending to be opposed to deflation, but missing their target year after year after year. "We'll do better next year, I promise." Jens Weidman seems to have learned from the Japanese:

Mr. Weidmann said he is aware of the risks of too-low inflation. The ECB targets inflation rates just under 2% over the medium term. Annual eurozone inflation was 0.3% in September, a five-year low. However, "the trough of inflation should soon be behind us," he said.
The fact that 10-year German bond yields have fallen to 0.87% suggests that nobody believes the ECB is going to hit its inflation target. I doubt even Weidmann is that clueless.

With level targeting things would be much different. Suppose the target was set at 1.9% inflation, and we had 0.3% inflation this year. In that case the ECB would have to shoot for 3.5% inflation next year, or 2.7% inflation over the next 2 years, to get back on the 1.9% trend line for the price level. Level targeting keeps central banks honest. It stops them from being dishonest and corrupt. Monetary policy becomes a purely technical exercise, as the debate over the proper long run inflation rate is over. The Greek and German representatives would vote in similar ways. There would be no more conservative hawks or liberal doves, just wise owls.

PS. Obviously I'd prefer level targeting of NGDP, not prices. But even level targeting of prices (more politically acceptable in Europe) would have a dramatic impact on the eurozone, leading to much faster real GDP growth over the next few years.

PPS. This is just one of many reasons why I have no interest in highly technical DSGE models "proving" that this or that policy is "optimal." These models leave out all the important things in life, such as whether policymaker corruption would be more severe with growth rate or level targeting. Mathematical models "assume a can opener," i.e. an honest central banker.

PPPS. I was a strong hawk in the 1970s, neutral in the 1990s, and a strong dove since 2008. How many economists can say that?

I will be traveling today, and slow to answer comments.


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CATEGORIES: Monetary Policy




COMMENTS (15 to date)
ThomasH writes:

OK, how about a DSGE model in which there is a price level trend target? [Not from you, Scott, but maybe from -- who? -- Noah Smith?]

I already "requested" a DSGE model with a stable NGDP trend model over at "Mainly Macro" :)

Another request: I never saw (or maybe I was just to dim to understand) an explanation of just why the brief experiment with monetary base targeting was "unsuccessful?"

Nick Rowe writes:

Scott: yep. There is monetary policy strategy (which target do we aim at?) and monetary policy tactics (how do we hit that target?). No individual economist should be consistently a dove or a hawk on that second tactical question.

ThomasH: Any(?) DSGE model that assumes the central bank targets inflation can easily(?) be converted into a DSGE model that assumes the central bank targets the price level or NGDP. You just have to change one(?) equation -- the central bank's reaction function. (I put the (?) in because there may be some weird cases I haven't thought of.)

Yancey Ward writes:
Level targeting keeps central banks honest.

This is simply hilarious. According to you, they are already corrupt because they don't actually aim at the target they claim to be aiming at (I agree with this assertion, by the way), but then you claim they will be forced to be honest by aiming at another target, or aiming at the same target in another way. Where, exactly, have you taken their free will away?

Don Geddis writes:

@ThomasH: Monetary base targeting fails because spending (NGDP) is MV, but V is not stable. Volatile spending is what causes business cycles. Hence stable MB targets are not sufficient to smooth business cycles.

@Yancey Ward: A level target prevents you from dismissing your past errors. You can make the argument (as many central bankers do) "I've been wrong the last five years in a row, but that wasn't my fault, and THIS year I'll be right!" But with a level target, your past errors force your future actions, regardless of how you "feel" about them, or what excuses you try to make.

Put another way: CBs are not corrupt in the sense of evil or embezzlement or crony capitalism or personal selfishness. They are broken because it's too easy to logically rationalize that you're "doing the right thing" for society, despite all your past failures. A level target forces you to deal with your past failures, and makes it much more difficult to rationalize them.

Ken from Ohio writes:

Prof. Sumner is describing the fundamental Eurozone problem. The lack of rules based monetary (and fiscal) policy.

The ECB has a 2% or less inflation target. But that 0-2% continuum becomes a political debate between the monetary hawks and doves. So far it seems like the hawks are winning.

So if the doves were to win and the ECB moved towards 2%, what tactic would the ECB use to acheive 2%.

If the ECB began a QE program of asset purchases, what bonds would it buy? The German 10 year is currently near an all time low yield of 0.9%. Austria (1.1%), Belgium (1.2%), France (1.3%) Netherlands (1.0%), are also at or near all time low yields. Would these countries allow an ECB QE program to further distort their bond markets?

The exception is Greece, with a current yeild of 6.7%. But a QE program that purchased Greek bonds would be considered an illegal debt bailout.

A few years ago, there was a lot of talk about the need or rules based, Eurozone fiscal integration. But so far there has been no progress on this.

The current ECB problem speaks to the need for a rules based Eurozone monetary policy (that proactively defines both strategy and tactics). We will see if there is enough political will to accomplish this. It seems doubtful.

A NGDP target rule of 4-5% would lead to monetary expansion (at this time the closest to 5% NGDP is Germany at 2.3%) . But, again, that rule would have to be accompanied by a set of agreed upon tactics.

The current ECB problem also reinforces the misguided initial concept that the Eurozone was or could become an OCA - Optimal Currency Area. Obviously, we are seeing that a one size fits all monetary policy is not working. And a strict rules based policy - that has a chance of working - does not seem to be forthcoming.

Don Geddis writes:

Ken: "The ECB has a 2% or less inflation target."

Really? That's certainly how they seem to be acting, but is "or less" part of some well-known widely-agreed mandate (presumably, from before this crisis)? I've never heard anyone claim that "or less" was in the actual ECB charter.

Ken from Ohio writes:

Don - you make a good point.

What actually is the ECB inflation target mandate? The way I have understood it is that the genesis of the common currency was to accomplish 2 things:

1) Elliminate currency risk from the various Eurozone sovereign debt markets. (Of course this backfired when Greece used this advantage to borrow cheaply and run up their debt)

2) Stabilize cross boarder business contracts-in order to facilitate trade.

In order to accomplish these two things, inflation and inflationary expectations must remain low.

From this I have always inferred that the ECB inflation target was intended to stabalize the currency such that the Euro would never have its purchasing power degraded by more than 2% in any given period.

So I have always considered the ECB inflation target to be a currency stability mandate. Therefore 2% or less.

In 1997 when the ECB was born, I do beleive that stability of the common currency was the main objective


The question is why the ECB has not been more expansionary, given the economic woes of the Eurozone?

I don't think it is because the ECB leaders are stupid or corrupt.

My best answer is that the ECB is paralized by Eurozone political factions, and the lack of politically acceptable policy tools to implement an expansionary policy.

Ken from Ohio writes:

Just to make sure that I remembered things correctly, I did a quick check.

Indeed, the ECB has a single mandate of price stability defined as inflation of 2% or less. Article 127(1) of Treaty of the Functioning of the European Union.

Of importance is that this is a single mandate. Unlike the dual mandate (Humphry Hawkins) of the American Fed, the ECB is committed to price stability.

There is no statutory allowance for the ECB to use monetary policy to stimulate GDP growth.

And that, As I've commented earlier is the ECB's mode of paralysis.

It lacks the statutory power, political will, and acceptable policy tools to implement an expansionary policy of a NGDP growth target of 4-5%.

The ECB is not stupid or corrupt, it is just stuck.

And so, it seems, is the entire Eurozone

Scott Sumner writes:

Thomas, I have mixed feelings about the money targeting experiment (which I believe targeted M1, not the base.)

1. I don't think it was ever given a fair chance.

2. I think if it had been given a fair chance it would probably not have been optimal. NGDPLT is better.

Yancey, There is no such thing as free will; actions are determined by the laws of science.

There are many possible reforms of government that make corrupt officials less corrupt. For instance, privatization and deregulation. So yes, I believe reforms can make people less corrupt.

Ken, Agree the eurozone is not a OCA. They could buy debt from each country equal to 5% of each country's GDP. That's no bailout of Greece. But of course level targeting is far better than QE.

The current ECB target would call for a much more expansionary monetary policy. They are not "stuck," they are choosing to create mass unemployment. They are choosing to ignore their target.

Ken from Ohio writes:

I can't accept that the ECB leadership would choose to create mass unemployment. That choice would be made only with a corrupt and malicious intent. And the ECB leadership is neither corrupt or malicious.

I invite all involved to review the Bloomberg News of Oct.12. this describes the political fight going on within the ECB. Draghi wants to expand the ECB balance sheet by 1T Euro. But Weidman of Germany is resisting this. The controversy revolves around just what the inflation target is, and what policy tools the ECB can use to expand.

As I previously commented, buying soveriegn debt is off limits, and buying private assets may be illegal.

As I said, the ECB is not corrupt or malicious, it is just stuck in a political and policy battle.

And for now, the Eurozone is stuck too.

Lorenzo from Oz writes:

Being a "hawk" or a "dove" signals what you care about. Now, that does mean that such signalling apparently trumps their policy role, but the latter is temporary, identity is more permanent and matters for subsequent social placements (including jobs).

Lorenzo from Oz writes:

I should add, that my point actually makes the argument for level targeting stronger, precisely because it incorporates history, increasing accountability.

And policy/institutional design is clearly able to reduce corruption. My favourite example is that mid C18th British politics were largely dominated by corrupt rent-seeking, Then there was almost a century of winding back special privileges, licenses, monopolies and official discretions generally. By mid C19th, British politics had a high reputation for probity.

Since corruption is the market for official discretion, it is not hard to see that reducing official discretions reduces the market for corruption.

Don Geddis writes:

Ken: "price stability defined as inflation of 2% or less. Article 127(1) of Treaty of the Functioning of the European Union."

Fantastic. That's exactly what I was hoping for, a legal reference to your claim that the ECB is mandated, by charter, to target 2% inflation "or less".

Except ... your reference doesn't actually show that. Article 127(1) says

The primary objective of the European System of Central Banks (hereinafter referred to as "the ESCB") shall be to maintain price stability. Without prejudice to the objective of price stability, the ESCB shall support the general economic policies in the Union with a view to contributing to the achievement of the objectives of the Union as laid down in Article 3 of the Treaty on European Union. The ESCB shall act in accordance with the principle of an open market economy with free competition, favouring an efficient allocation of resources, and in compliance with the principles set out in Article 119.

I see no reference even to 2%, much less to "2% or less". (In fact, without an explicit number, "price stability" to a layman -- or Austrian! -- probably means a 0% target, no inflation at all. It already requires a sophisticated understanding of macro, in order to interpret "price stability" as meaning something more like a 2% target. But then "2% or less" makes no sense.)

Again, I ask you the same question: what is your evidence that the ECB's mandate allows them to be content with ANY inflation rate below 2%?

Ken from Ohio writes:

Don-

Sorry - my first reference was incorrect. It was a link to the source.

So the actual source is from the ECB website Monetary Policy Handbook Sec. 3.4 p 64

The Treaty on the Functioning of the
European Union clearly establishes the
maintenance of price stability as the
primary objective of the Eurosystem.
In order to specify this objective more
precisely, the Governing Council of the
ECB announced the following
quantitative definition in 1998: “Price
stability shall be defined as a
year-on-year increase in the Harmonised
Index of Consumer Prices (HICP) for
the euro area of below 2%. Price
stability is to be maintained over the
medium term”. Following a thorough
evaluation of its monetary policy
strategy in 2003, the Governing Council
further clarified that, within the
definition, it aims to maintain inflation
rates “below, but close to, 2% over the
medium term”.


The last sentence related to the 2003 clarification clearly states that the policy goal is below but close to 2%.

The current Eurozone inflation rate of 0.3% likely does not meet the definition of "close to" 2%.

And so it seems that within its price stability policy mandate, the ECB as room to expand - to achieve something close to 2% inflation.

If it can actually achieve the 2% target, that would put NGDP for the Eurozone just below 3%. Still short of a 4-5% NGDP target. But if continued over time the 4-5% goal may be reached in the next few years (medium term)

My big question is what policy tools the ECB has to achieve this. I need to check into it further, but I am not sure that purchasing private assets is legal.

As I previously commented the standard avenue for monetary expansion (purchase of sovereign debt) seems to be unavailable given the current state of the bond market.

It will be very interesting to see how the ECB/Eurozone gets itself "unstuck"

Don Geddis writes:

@Ken: Thanks for the followup. Very helpful!

It appears that the policy you had in mind "2% or less", was indeed the ECB's charter, in 1998. And it appears that it was changed in 2003 (just in time!) to use "almost 2%" as a target, not just a maximum. Very interesting.

Whatever your concerns about current concrete actions, it seems clear that the ECB had ordinary rates above zero for most of the financial crisis, and in fact raised rates in the middle of the crisis. So, even aside from your concern about "what do they do now?", the ECB bankers do not appear to have followed their own mandate, even when they had an easy choice.

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