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FT.com | Willem Buiter's Maverecon | What's left of central bank independence?
The modern independent central bank was born in New Zealand in 1989. It had a short life.  The onset of the financial crisis of the north Atlantic region in August 2007 signalled the beginning of the end.  Today, only the ECB still has a significant degree of operational independence left, and it will have to give that up if it is to be effective in the current phase of the crisis. In other words, the ECB is the last central bank to understand that, if it is to play a significant financial stability role, it cannot retain the degree of operational independence it was granted in the Treaty over monetary policy in the pursuit of price stability.

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Fundamental target independence - the right to choose its own fundamental objective or objectives - is possessed by no central bank.  Even the most independent of all central banks, the ECB, has its multiple fundamental objectives laid down in an external document - the Treaty Establishing the European Community.  Article 105 states that "The primary objective of the ESCB shall be to maintain price stability. Without prejudice to the objective of price stability, the ESCB shall support the general economic policies in the Community with a view to contributing to the achievement of the objectives of the Community as laid down in Article 2. The ESCB shall act in accordance with the principle of an open market economy with free competition, favouring an efficient allocation of resources, and in compliance with the principles set out in Article 4."

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Operational independence is the freedom or ability of a central bank to pursue its objectives (regardless of who sets them) as it sees fit, without interference or pressure from third parties. It is not a binary variable but a matter of degree. Operational independence from an elected, sovereign government is not easily achieved.

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There can be little doubt that the ECB is the central bank with the highest degree of formal or legal operational independence. Since it also sets its own operational objectives (medium term HICP inflation below but close to two percent per annum ), it can also be characterized as the most independent central bank, when operational independence and target/goal independence are taken together.  The ECB's operational independence and its mandate are enshrined in the Treaty establishing the European Community and the associated Protocol. These can only be amended through a Treaty revision requiring the unanimous consent of the EU member states (currently 27 in number).

Interestingly, he "conventional" a monetary policy that has been in effect only since 1989 by his own analysis, and that is based on an economic theory - monetarism - which holds sway among economists and policymakers only since the 1970's.

Unconventional monetary policies require close central bank - Treasury cooperation

Every time a central bank makes a loan at the discount window or engages in a reverse repo secured against private collateral, it takes credit risk (default risk).  In the Euro Area, the ECB even takes credit risk when in accepts the Treasury debt of some of the Euro Area member states as collateral in its lending operations.  There is no guarantee that cross-border fiscal solidarity in the Euro Area will ensure that sovereign debt issued by fiscally incontinent member states will be made good by Germany and other member states with deep pockets.

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It is a mistake for central bankers to express, in their official capacities, views on what they consider to be necessary or desirable fiscal and structural reforms. Examples are social security reform and the minimum wage, subjects on which Alan Greenspan liked to pontificate when he was Chairman of the Board of Governors of the Federal Reserve System, and Ben Bernanke's tendency to lecture on everything, from equality and opportunity to teenage pregnancy. It is not the job of any central banker to lecture, in an official capacity, the minister of finance on fiscal sustainability and budgetary restraint, or to hector the minister of the economy on the need for structural reform of factor markets, product markets and financial markets. This is not part of the mandate of central banks and it is not part of their areas of professional competence.

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Even a nano-second of reflection will convince you that financial stability requires the close cooperation and coordination of the source of ultimate, unquestioned liquidity (the central bank), the ultimate deep pockets (the Treasury) and the supervisor/regulator.  Recognition that such a tripartite or quadripartite arrangement is necessary for financial stability (both ex-ante, that is, the prevention of instability, and ex-post, that is, dealing with the instability that happens is spite of (or because of) the ex-ante best efforts) does not answer the question as to how many institutions should be involved, and what the lines of authority among them should be.

We live in interesting times.

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
by Carrie (migeru at eurotrib dot com) on Wed May 6th, 2009 at 06:26:08 AM EST
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