Thursday, September 20, 2007

Saber-rattling at central banks 

Greg Mankiw points out a press release by Rep. James Saxton that called for a Fed Funds rate cut of 25 basis points and says it's the last thing we need. Mark Thoma says "we should be very careful about compromising the Fed's ability to act independently of the rest of government."

The Milan conference was about this very point. So permit me to share a couple of thoughts. First, unlike the ECB, which has price stability as its sole objective , the Federal Reserve still operates under a dual mandate for both price stability and to promote economic growth. It is a creation of Congress. As John Wood presented at the conference, in the confirmation hearings for the renomination of William McChesney Martin in 1956, Senator Paul Douglas said:
I have had typed out this little sentence which is a quotation from you: �The Federal Reserve Board is an agency of Congress.� I will furnish you with scotch tape and ask you to place it on your mirror where you can see it as you shave each morning.
The Federal Reserve has some quasi-Constitutional status as an independent agency, but it is not above Congressional review. The degree of Congressional discretion has been long debated, but its protector is not a law; it's the bond market. (That point, by the way, is implicit in Alan Greenspan's direct-to-classic interview with Jon Stewart Tuesday night.)

This takes me to the second thought then, which is how independent SHOULD a central bank be. That is, given economic policy is something governments will do -- should they do any? take that question somewhere else please, no time for it here -- what is the optimal amount of delegation the government should give to a committee of experts? To get at that question (though it might not have been her intent) there was a presentation at the conference by Katrin Ullrich of the Centre for European Economic Research which posed the question of whether you would want to delegate fiscal policy at all. The reaction of the workshop was quite interesting; basically, you can't delegate fiscal policy because "taxing and spending the receipts of those taxes is what legislatures do." The reason we delegate the job of price stability to the sages like a Greenspan or a Trichet or a Bernanke is not just because they are smarter, more conservative (in the sense of more inflation-averse, not a political statement), but because monetary policy doesn't create winners and losers. But of course, unexpected inflation does, through the debtor-creditor hypothesis that most of my generation of economists had to learn in grad school.

Certainly on balance, economists have decided that countries where central banks are insulated from political pressure and have clear goals for policy do better in providing price stability. That's not the point -- it's whether elected officials can ever say anything about monetary policy. Most of the time what they say is self-serving blather. But if the optimal degree of delegation was 'complete' we'd all have the gold standard or a currency board and be done with it. Some economists may feel that's the right answer, but it isn't the majority. Every once in awhile, central bankers should look in the bathroom mirror.

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