Martin Sandbu in the FT picks
up on my post
on central bank mistakes. While he says that the first and third I
identify are “on point”, he says the second is simply wrong. I
think this is because he (and many others) misunderstand the point I
am making, which in turn probably means I’ve failed to be clear
about it. But it is really important.
My second criticism is that central banks did not make it clear what
the impact of reaching the zero lower bound (ZLB) was, and as a
result were too quiet about the adverse impact of fiscal austerity.
That is not the same as saying there is nothing central banks can do
at the ZLB, or that unconventional monetary policy is impotent. As I
said in the post, what the ZLB meant is that central banks could no
longer do their job effectively, and that unconventional policy “was
untested, and it is just not responsible to pretend otherwise”.
Take three instruments: interest rate changes, fiscal policy changes,
and unconventional monetary policy. The first two are tried and
tested. There is still much uncertainty, but we can have a good guess
at orders of magnitude when it comes to working out how much we need
to do to achieve some end result (particularly when interest rate
changes will not undo fiscal policy’s effects). Unconventional
monetary policy has some impact, but we have little prior knowledge
of how big that effect will be (or equivalently, how much we need to
do to achieve some end result.) Given lags between instrument changes
and results, this is a very serious disadvantage.
A simple analogy. The central heating is broken, and it is freezing
outside. It can be fixed quickly with the right kit. You ring two
plumbers to come and fix it. One says he can be there immediately,
the other says they can come in two hours. You are getting very cold,
so you naturally choose the plumber who can come straight away.
However when they arrive, they tell you their equipment required to
fix the problem quickly is broken, but they can nevertheless probably
bodge something within the next day or two. You ring the other
plumber, and they do have the right equipment. What would you do?
Would you not get cross at the first plumber for not telling you
their equipment was not working properly when you first contacted
them? Now suppose the first plumber did not tell you anything, and
you only found out about the kit that could have fixed the problem
quickly later on. Would you employ that plumber again, particular
when you discover that since his ‘repair’ your central heating is
not working as well as it used to?
In a way this strikes at the core of the independence issue. Without
independence, the government would be able to choose the best
instrument available, which at the ZLB is fiscal policy. But central
banks have been made independent and the task of stabilising the
economy has been delegated to them. This institutional change should
not mean that we no longer use the best instrument to do the job. [1]
But if the central bank fails to be frank, perhaps because it feels
bad about admitting that it no longer has the best tools to do the
job, that is a clear mistake on its part. In this respect it is not
important whether the central bank being honest and clear would have
actually made a difference on this occasion. That it might have done is
all that matters.
I think central banks can at this point get confused with political
neutrality. But pointing out the facts as they see it about their own
relative competence should never be seen as ‘political’. Here
Tony Yates makes
a good suggestion, which is that the central bank should be mandated
to comment “on whether its ability to meet the inflation target [or
whatever its objectives are] was being hampered by government fiscal
policy.”
Advocacy blogging is so ubiquitous that some presume that in pointing
out this and other mistakes I must be arguing against central bank
independence (CBI). To repeat, I am not. What I think is indisputable
is that CBI done badly can be worse than no independence. It does not
serve the cause of well designed and well implemented central bank
independence to gloss over past mistakes.
[1] Suppose you erroneously
think concerns about government debt were valid. Was that a
justification for central bankers to argue against fiscal expansion?
Absolutely not. With QE, any fiscal expansion could have been money
financed. What central bankers should have said is that short term
concerns about excessive government debt were unfounded, because they
were acting as a lender of last resort. They did not say this.
