Scott Sumner  

Central banks should do their job

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The title of this post sounds like a truism, and yet it's actually highly controversial. In my previous post I pointed out that the ECB was not hitting its 1.9% inflation target, and apparently has no plan for doing so in the future.

In a new article, William Pesek recommends that the Bank of Japan stop doing its job, as a way of pressuring Prime Minister Abe to enact the BOJ's preferred policy agenda, in areas unrelated to monetary policy.

Analysts are expecting a rush of new fiscal stimulus early in the new year. Kuroda, too, will face pressure to one-up himself when the BOJ meets on Friday. Like addicts looking for their next fix, markets want the central bank governor to outdo his "shock-and-awe" from April 2013 and recent Halloween surprise on Oct. 31, when he boosted bond purchases to about $700 billion annually.

It's time for Kuroda to do exactly the opposite: hold his fire and prod Abe to begin doing his part to push through his "third arrow" structural reforms. To this point, Kuroda has been a dutiful and circumspect policymaker -- perhaps to a fault. Other than a brief flash of impatience with Abe's foot-dragging in a May Wall Street Journal interview -- when he said "implementation is key, and implementation should be swift" -- Kuroda has held his tongue. Yet he bears a responsibility to play the honest broker role that monetary powers have over the years -- from Paul Volcker at the Federal Reserve decades ago to Raghuram Rajan at the Reserve Bank of India today.

On Friday, Kuroda should tell reporters, "Now that the election is over, it's up to Prime Minister Abe to carry out the will of the people and deregulate the economy. For now, we at the BOJ have done all we can -- and are willing to do -- to make Abenomics a success."


Kuroda's mandate is not to "make Abenomics a success," it is to hit a 2% inflation target, and thus far he has fallen short of that goal. The target is probably not optimal, but economies do better when central banks follow a consistent and predictable monetary regime. There are two problems with encouraging central banks to miss their targets:

1. It undercuts democracy and transparency. Political regimes work best when each part of the government has clearly defined tasks, and is held accountable for achieving its policy goals. The monetary authority should do monetary policy, and the Japanese government should do fiscal policy and structural reforms.

2. Yes, it's theoretically possible that damaging the Japanese economy through excessively tight money will lead to even greater gains elsewhere, if it encourages structural reforms. But the downside risks are much greater. History is littered with cases where failed monetary policy led to harmful economic changes (the NIRA in 1933, or Argentinian moves toward statism after 2002.) And of course there are cases where bad monetary policy led to disastrous political changes, notably the German deflation of 1929-32, which led directly to a Nazi government.

It's simply too risky to intentionally damage an economy in one area in the hope that it pressures a different part of the government to adopt better polices in another area. Central banks need to follow a clear and transparent policy rule, and let other parts of the government address other issues. Central banks should do their job.


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CATEGORIES: Monetary Policy




COMMENTS (4 to date)
Lorenzo from Oz writes:

Yes. But that would mean taking responsibility and a lot of what is going on seems to be central bankers evading that. Including construing their responsibility in a way which is congenial (but is still an evasion of responsibility).

Ken fromOhio writes:

I have always wondered why central banks are so resistant to rules based policy.

There are many reasonable monetary policy rules - NGDP targeting, Taylor, etc.

My theory on central bank resistance to rules is based on 2 things:

1): The Keynesian legacy ...whereby government has come to consider itself capable of fine tuning the economy. It considers that if it just pulls the proper levers at the proper time - based upon its discretion and insight, all will be well.

2); Public choice ....If a government agency (in this case the central bank) functions based upon rules, the rules become more important than the agency, and the agency with all of its employees is then threatened with irrelevance and possible extinction.

Nathan W writes:

There seems to be some disagreement in the US as to what we should expect of the central bank. On the one hand, we praise its independence, yet anticipate that it will be sensitive to employment effects when making decisions which formally revolve around a targeted inflation rate. Does the fed target inflation only? The extent to which it targets other things?

In fact, I think the fluidity of the answer and the limited uncertainty in this regard is a good thing, because it proves that they are not "too" rule bound when other factors are relevant to the populations affected by their decisions.

In response to a comment above, then, I would suggest that "rules-based policies" can serve as very useful guidelines, but will almost ensure highly suboptimal decision making at precisely those times when the wrong decisions have the greatest capacity to inflict the greatest damage on the greatest number of people. It means that they will also be responsible for making mistakes, as compared to reducing their role to one of rigidly satisfying some decision-making rule.

Scott Sumner writes:

Nathan, I don't think anyone would deny that we'd be much better off if the Fed had followed its own announced policy mandate during 2008-09, instead of the actual policy (which sharply deviated from their mandate.)

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