Rethinking Central Banking

An event at the Brookings Institution launched a new report, Rethinking Central Banking, by a team of economic eminences including Barry Eichengreen, Raghu Rajan, Eswar Prasad, Carmen Reinhart, Kenneth Rogoff, and others. I've only skimmed it so far but the presentation was interesting and the report looks valuable. The basic thesis is that central banking has become a lot more complicated than it used to be, and the "dominant framework guiding central banking practice" therefore needs to change.

The first recommendation is that central banks should go beyond their traditional emphasis on low inflation to adopt an explicit goal of financial stability. Macroprudential tools should be used alongside monetary policy in pursuit of that objective. Mechanisms should also be developed to encourage large-country central banks to internalize the spillover effects of their policies. Specifically, we call for the creation of an International Monetary Policy Committee composed of representatives of major central banks that will report regularly to world leaders on the aggregate consequences of individual central bank policies.

There is substantial pressure on central banks to acknowledge the importance of still other issues, such as the high costs of public debt management and the level of the exchange rate. Central banks are more likely to safeguard their independence and credibility by acknowledging and explicitly addressing the tensions between inflation targeting and competing objectives than by denying such linkages and proceeding with business as usual. Central banks should make clear that monetary policy is only one part of the policy response and cannot be effective unless other policies--fiscal and structural policies, financial sector regulation--work in tandem.

I'm sure the report is right that central banking needs to be more broadly conceived than before, but I have a question. What, if anything, remains of the traditional case for central-bank independence once this is done? The report seems to take it for granted (as above) that central-bank independence should be preserved. Why? The standard case rests heavily on the simplicity of the assignment--low inflation--and the lack of any long-term trade-off between that goal and full employment. (The standard case chooses not to worry too much about the short-term trade-off.) Complicate the assignment and the trade-offs and central banking starts to look more like politics by other means.

An honest technocrat, with no intention of ever running for elected office, might dare to say that central bank independence is desirable because politics in so many countries (not least in the US) is broken. Admittedly, by the same reasoning, most other government functions should likewise be shielded from voters and politicians. I only wish they could be, our recklessly honest technocrat might say--but in those other cases it is too late. Central-bank independence is not yet a lost cause. Let us hang on to it as long as we can--and extend it across more functions, if possible.

An advocate of democracy--not to mention voters and their elected representatives--would  find that hard to swallow. My point is, if you rethink central banking, you also need to revisit the case for central bank independence, and not much of it may withstand the examination.