SAN DIEGO – Federal Reserve Bank of St. Louis President James Bullard gave remarks Friday on “The Global Battle Over Central Bank Independence,” as part of a National Association for Business Economics (NABE) panel discussion at the AEA/ASSA annual meeting.
During his presentation, Bullard discussed how financial crisis aftershocks have partially broken down the consensus on the wisdom of central bank independence. “Financial crisis aftershocks have introduced a ‘creeping politicization’ of central banking globally,” he said, and added that “the macroeconomic performance of nations with politicized central banks has historically been quite poor.”
He stated that to the extent that central bank independence is weakened globally, macroeconomic stabilization policy will not be executed as well in the future as it has been since the mid-1980s. “‘Fiscalization’ of monetary policy will tend to complicate the policymaking process substantially,” Bullard explained. He cited as an example the European Central Bank’s (ECB’s) “outright monetary transactions” (OMT) program. One interpretation of the OMT is that it is a fiscal-type operation, and that ordinary monetary policy has become part of the negotiation over the fiscal package, Bullard said. “This has altered the response of the ECB to the European recession.”
In discussing the consensus on central bank independence, Bullard said that effective macroeconomic stabilization policy has to be implemented in a timely manner in reaction to macroeconomic shocks; for example, through the use of Taylor-type policy rules. Furthermore, he noted that fiscal policy adjustments through tax, spending and borrowing policy tend to be slow and must be carefully negotiated, while monetary policy can be implemented in a timely and technocratic manner. Hence the conventional wisdom: “Focus fiscal policy decisions on the medium and longer run,” and “delegate monetary policy to an independent authority,” he stated.
Bullard said that the goal is to have an effective macroeconomic stabilization policy. “If monetary policy is not delegated to an independent authority, then it too becomes part of the slow and complicated negotiations associated with fiscal policy,” he explained. “The society would be left without a way to make timely policy adjustments in reaction to macroeconomic shocks,” he said, noting that the result would be more macroeconomic volatility. “The consensus therefore suggests that macroeconomic outcomes will be better with an independent central bank.”
In recent years the central banks in the G-7 countries encountered the zero lower bound on nominal interest rates. As a result, many have talked about the need for fiscal authorities to conduct macroeconomic stabilization policy, Bullard said. “However, the usual political hurdles asserted themselves and led to a hodgepodge of fiscal policy responses not particularly well-timed with macroeconomic events.”
As an aside, he pointed out that the zero lower bound does not necessarily imply a need for fiscally-oriented macroeconomic stabilization policy. “Central banks have conducted stabilization policy effectively even while at the zero bound,” primarily through the use of two key tools – quantitative easing programs and forward guidance. As evidence, he noted that “inflation has generally stayed near target instead of falling dramatically.” (For further discussion, see Bullard’s article published in 2012, “Death of a Theory.”)
Nevertheless, Bullard said, many see fiscal stabilization policy as desirable in the current context. He cited one idea suggested by some that the central bank take actions that are cumbersome to accomplish through a democratically-elected body, which may be seen as one way to get the relatively speedy monetary policy decision-making into a fiscal policy context. However, “This is a ‘creeping politicization’ of monetary policy,” he cautioned, adding that in such a case, “some central bank independence is lost since the monetary authority is taking actions at the behest of other policy actors.” Furthermore, he stated, “Monetary policy decisions then become wrapped up with fiscal policy decisions, slowing down the process through negotiation and making it considerably more complicated.”
Rather than asking a central bank to design programs outside of its area of expertise, Bullard proposed an alternative approach. “Democratically-elected institutions could certainly create a fiscal stabilization authority, perhaps modeled on the FOMC (Federal Open Market Committee), that could make technocratic fiscal decisions in speedy reaction to macroeconomic events,” he said, adding that such an authority could be allowed to act within assigned limits and under a clearly-specified mandate with periodic reporting.
European Central Bank’s Outright Monetary Transactions
Bullard discussed the ECB’s recent OMT program, which has been widely interpreted as a promise to buy the sovereign debt of individual nations. He noted that should purchases occur, they are conditional on the nation meeting certain fiscal targets; in addition, purchases would be sterilized, unlike the quantitative easing programs in the U.S. and the U.K.
“This is ‘fiscalization’ of monetary policy: Asking the central bank to take actions far outside the remit of monetary policy,” Bullard said. He noted that the analog in the U.S. would be a promise to purchase state debt in exchange for the state maintaining a fiscal program considered prudent by the central bank. “Assistance like this from a central authority to a region is best brokered through the political process in democratically-elected bodies,” he said, adding that the ECB is in essence substituting for a weak pan-European central government.
Furthermore, Bullard noted that by nearly all accounts, the European monetary policy process has been bogged down by political wrangling over the OMT and other programs. One could argue, he said, that the monetary policy response to the European recession has been muted compared to more ordinary circumstances. “Ordinary monetary policy provides or removes monetary accommodation in response to macroeconomic developments,” Bullard said. Yet, he pointed out, the ECB has taken little direct action in response to the Eurozone recession; namely, it has not significantly adjusted the policy rate, employed quantitative easing or used forward guidance.
“By conducting a fiscal action, the central bank has been pulled away from its ordinary macroeconomic stabilization policy,” Bullard said. “Standard monetary policy has become wrapped up in the fiscal policy package and subject to the negotiations that surround that package.
“This defeats one of the original purposes of central bank independence: Having a monetary authority that can react to macroeconomic shocks quickly and effectively,” he added.