Jean-Claude Trichet, ECB president, sometimes refers to the “brotherhood of central bankers”. He rarely criticises, even indirectly, his colleagues elsewhere in the world. At an ECB conference in Frankfurt that has opened this afternoon, Mr Trichet noted recent comments by Ben Bernanke, the US Federal Reserve chairman, describing an inflation rate of “about 2 per cent or a bit below” as consistent with the Fed’s mandate. The developed world’s two largest central banks “could hardly be more closely aligned” on inflation aims, he exclaimed.
But he drew a clear distinction when it came to the use of “non-standard measures” by the world’s central bankers. One view was they could be used like “engaging the four-wheel drive” once the end of the road had been reached. That was a clear reference to “quantitative easing” by the Fed.
In contrast, the ECB used non-standard measures to “remove the major roadblocks in front of us”.
The European Central Bank’s monthly bulletin, just released, has a retro feel about it. I’ve flipped through its 99 pages (saving the statistical annexe for later) but failed to find any reference to the crisis hitting the eurozone’s periphery, apart from a few factual points on bond spreads.
There were certainly plenty of questions it could have addressed. For instance, what exactly is the current aim of its government bond purchase programme? Launched in May, at the height of the eurozone crisis, the programme had an initial “shock and awe” function, along with the political actions taken then.
Now it seems neither one thing nor the other – it is not a large-scale asset purchase scheme like QEII, nor has the programme been formally ended (as Axel Weber, Bundesbank president, would prefer). Officially, the programme is about restoring the functioning of markets, but what does that mean right now?
A speech just made by an ECB board member illustrates perfectly the divergent fortunes of the ECB, Bank of England and the Fed.
In the UK and US – where the recovery is more fragile – markets, economists and journalists are increasingly looking to their central banks for a monetary solution. Not in Europe. The economy is on a “good recovery track”, which can be ensured by fiscal responsibility and structural reform, says the ECB. So, no monetary solution here: responsibility is firmly back with the state.
Imagine that in January, you will become your country’s chief firefighter, but that the very best reports of smoke currently available are unreliable and intermittent. Scared?
Well, the European Systemic Risk Board is due to launch in January, and the ECB’s vice president has just pointed out that, on current data availability, the Board would struggle to do its job. That job, as a quick reminder, is to “assess and prevent potential risks to financial stability in the EU.” No small task, with markets febrile and bank bail-outs still in vogue.
The ECB has a fair bit of data already, but it is geared towards monetary policy rather than macro-prudential regulation. So, what’s missing?
The IMF has tried to rally the troops at a meeting in China, urging central bankers to maintain the international co-operation forged during the financial crisis, and looking to Asia to lead the way.
At an IMF-sponsored meeting of central bankers and regulatory luminaries in Shanghai, an “important consensus” was reached, according to PBoC deputy governor Yi Gang, on the need for international co-operation in ensuring strong macro-prudential policies, because systemic risks “are very likely to spread over borders.” In practice, this means central banks and national regulators taking on more international roles.
Central banks also need to take a broader view domestically, said IMF managing director Dominique Strauss Kahn, seeming to suggest that financial stability would be part of central banks’ remits going forward. “Clearly, conventional macroeconomic policies and macro-prudential tools are intrinsically linked, just as price stability and financial stability are intrinsically linked,” Strauss-Kahn said. “We need a holistic approach, which means a changing role for central banks in the years ahead.”
One of the main things I took from chairman Bernanke’s speech last Friday was a wish to refocus attention on the Fed as an inflation-targeting central bank.
Although attaining the long-run sustainable rate of unemployment and achieving the mandate-consistent rate of inflation are both key objectives of monetary policy, the two objectives are somewhat different in nature.
Most importantly, whereas monetary policymakers clearly have the ability to determine the inflation rate in the long run, they have little or no control over the longer-run sustainable unemployment rate, which is primarily determined by demographic and structural factors, not by monetary policy. Thus, while central bankers can choose the value of inflation they wish to target, the sustainable unemployment rate can only be estimated, and is subject to substantial uncertainty.
Moreover, the sustainable rate of unemployment typically evolves over time as its fundamental determinants change, whereas keeping inflation expectations firmly anchored generally implies that the inflation objective should remain constant unless there are compelling technical reasons for changing it, such as changes in the methods used to measure inflation.
I think this highlights the enormous problems caused by targeting inflation without being willing to be admit that you have an inflation target. The Fed fondly imagines that the world understands it is targeting inflation. It is not a surprise it believes this: it talks to economists who run models in which it has a 2 per cent inflation target and to hacks like me who are misspending our lives studying Fed-speak.
Canada’s central bank is the latest to ask whether central banks should expand their remit beyond inflation targeting. “If we look only at interest rates, inflation and output, we may miss bubbles and other elements of systemic risk as they build,” Canada’s deputy central bank governor said on Tuesday.
Tiff Macklem said the Bank needed to develop models that include elements of banking and capital markets. “When the financial system is not working normally,” he said, “we cannot rely on the short-cut from interest rates to output and inflation.” The WSJ recently reported the Fed was also developing a more comprehensive model, the Quantitative Surveillance Mechanism (QSM).
It’s official: financial system stability is part of the Reserve Bank of Australia’s mandate. This doesn’t mean, though, that the RBA will be bailing out banks.
The Reserve Bank’s mandate to uphold financial stability does not equate to a guarantee of solvency for financial institutions, and the Bank does not see its balance sheet as being available to support insolvent institutions.
With little fanfare, a statement published on the Bank’s website “records [its] common understanding of the Reserve Bank’s longstanding responsibility for financial system stability… arrangements which served Australia well during the recent international crisis period.”
Adam Posen, an external member of the Monetary Policy Committee, has just sounded the alarm: not about a temporary double-dip recession, but about Japanese-style prolonged economic weakness, high unemployment, trade conflicts, and extremist politics. It is strong stuff. Monetary policy needs to do more to foster a stronger recovery, he says. Now.
His argument is worth reading in full because it is directed much wider than solely to other MPC members in the UK.
The one sentence summary. Policymakers should not settle for weak growth out of misplaced fear of inflation.
In a paragraph. Mr Posen believes output is clearly below any reasonable measure of potential, so worrying about an inflation problem is absurd. We must also not underestimate the potential for the economy to grow. If we do, that will destroy workforce skills and potentially productive machinery as well as inhibiting investment, creating a self-fulfilling bad outcome.
Adam Posen, one of the more outspoken external members of the Monetary Policy Committee, has dangled the intriguing possibility of the Bank shifting into “heavy-duty credit easing” if necessary.
The Bank had promised to release the remarks he made in the US last night and I understand the reason they have not is cock-up not conspiracy. That means we have to rely on wire reports of his words. Without much context, Bloomberg is reporting Mr Posen saying:
“Because we have only done quantitative easing up till now, our plan B or our next page in my opinion, and I’ve said this, is to shift into heavy-duty credit easing.”
For Bank of England watchers, this should come as little surprise. While the bank has usually emphasised the amount of money it has created (a liability on its balance sheet), Mr Posen has regularly highlighted the effect of QE on the assets markets. It is also not much of a departure. Mr Posen has repeatedly said similar things. In a speech last October he bemoaned the fact that:
“Other central banks were able to buy a wide range of assets from the private sector, under the heading of ‘credit easing,’ as described in Bernanke (2009), to good effect.”