Rich, George, Federal Reserve Bank of St. Louis Review
LEE HOSKINS HAS WRITTEN a fine paper on monetary policy. I share most of his views on the role and duties of central banks. Hoskins discusses why the conduct of monetary policy has been entrusted to central banks. He also examines the conditions that must be satisfied for central banks to play an effective policy role.
Hoskins' principal thesis is that central banks are needed to manage a standard based on fiat money. But a fiat standard imposes few constraints on central banks. If central banks are permitted to issue fiat money, there is always the risk that they will abuse their powers. Consequently, under a fiat standard it is necessary to ensure that central banks act in the public interest.
Why do central banks frequently harm the public interest by debasing the currency? Hoskins discusses several possible reasons. He dismisses the answers offered by public-choice economists and also rejects the notion that unsatisfactory performance of central banks is due to the pursuit of inappropriate targets or operating procedures. Instead, he maintains that "central bankers are suffering from a Keynesian hangover." Frequently they do not direct monetary policy solely at price stability but attempt to pursue multiple objectives that often conflict. Many central bankers attempt to achieve at least two goals--to keep prices stable and to smooth cyclical fluctuations in output and employment. Too often, Hoskins maintains, central bankers also try to manipulate the exchange rate with a view to strengthening the competitive position of domestic industry. Of course they do not pursue multiple objectives because of a character defect. They merely reflect prevailing opinions held by politicians, bankers, economists and other members of the general public.
In Hoskins' view, the performance of central banks could be much improved if they were granted independence from governments and given a single objective--price stability. The central banks--though independent--would not be allowed to choose policy objectives but would be given a clear legislative mandate to achieve and maintain price stability. Moreover, they would be accountable to the public for their policy actions.
I am largely sympathetic to Hoskins' suggestions. An independent central bank with a clear mandate to pursue price stability is likely to perform better than an institution attempting to respond to diverse and conflicting political pressures. I also agree with Hoskins that the social value of a credible price-stability objective is often underestimated, whereas the costs of eradicating inflation are overstated.
Thus I support Hoskins' call for committing central banks to a price-stability objective. In my view, however, the story does not end here. A clear price-stability mandate by itself is not enough to improve the performance of central banks. Even if we agree that the objective of monetary policy should be price stability, we still have to address a second question: How should central banks achieve and maintain a stable price level?
Hoskins plays down the problems of designing operational policy rules consistent with the price-stability mandate. Yet as practitioners of monetary policy know, the translation of such a mandate into specific policy rules is far from trivial. Switzerland offers a good case in point. I argue that the Swiss National Bank (SNB) possesses a clear mandate to achieve and maintain price stability even though Swiss law does not precisely define the objectives of monetary policy. This mandate, albeit informal, rests on a remarkable consensus among the Swiss public about the objectives of monetary policy.
The SNB's informal mandate explains why the inflation rate in Switzerland has tended to be low by international standards. Since the beginning of 1975--when Switzerland shifted to money stock targeting--inflation in Switzerland has averaged 3.5%. This average, however, still far exceeds the SNB's stated inflation target of 0 percent to 1 percent. …