HIRO MIYAZAKI: Hi, everyone. I'm Hiro Miyazaki, director of the Mario Einaudi Center for International Studies, also professor of anthropology here at Cornell. For those of you who weren't able to join us for the earlier sessions, I'd really like to welcome you to this conference, The Changing Politics of Central Banking, organized by the Enaudi Center, Meridian 180, and the Global Finance Initiative. I also want to thank our conference co-sponsors, the Institute for the Social Sciences and the Tobin Project. So I also want to thank our participants, some of whom have come from very far away to be with us in this gorgeous summer day.
Before I introduce our keynote speaker, I would like to invite you all to the 2016 [INAUDIBLE] Affairs Lecture, by Alan Blinder, who is about to arrive here from Princeton. Professor Blinder will talk about the evolving political economy of central banking tomorrow afternoon at 4:30 at the Statler Auditoriium. And there will be a public reception following that lecture. And I hope many of you will be able to join us for that.
So we have been having a very wonderful, very substantive conversation about the politics of central banking and what political science and anthropology have to say about this subject all day. And it is a real honor to introduce our keynote speaker, Adam Posen. Dr. Posen is a classic example of a thought leader. He is among the world's most informed and influential voices on the complex issues we are discussing here this week.
He also happens to be one of the foremost authorities on the Japanese economy, a topic that is really near to my heart. Adam Posen is currently president of the Peterson Institute for International Economics, in Washington, DC. That his work has been international is an understatement. Educated in the United States, he worked in finance in Germany following the unification, wrote the definitive book on Japan's economic crisis of the 1990s, advised the government that dug Japan out of that crisis, co-authored with Ben Bernanke a reform program for the US Federal Reserve, and served both as an advisor to the UK government and a member of the Bank of England's Monetary Policy Committee.
An article in The Atlantic a few years ago named Dr. Posen to its international team of superstar central bankers. We feel very fortunate to have him here with us. Please join me in welcoming Adam Posen.
ADAM POSEN: Thank you, Professor Miyazaki, for that very generous introduction. Thank you to all of you who came across campus to be here in person instead of watching this on live stream while flipping back and forth to the NBA playoffs. I am very grateful to Hiro Miyazaki, to Annelise Riles, to Jonathan Kirshner, to Heike Michelsen, and everyone involved who included me in this conference. It is indeed an exciting interdisciplinary event.
Interdisciplinary is a word that gets tossed around quite a bit. This is one where it actually seems to be real and working. And I give the various component institutions credit.
I'm also very glad and grateful to have the opportunity to be addressing an audience, not just of all the distinguished guests participating in the conference, but here at Cornell. Peter Katzenstein is in the audience. Peter's work and the work that Peter's inspired and guided through the years has been something I've looked to since the early '80s. And he and Jonathan Kirshner, in particular here, are leading the kinds of political economy that I am very much in favor of. And I'm delighted to be able to speak in front of them, even if not for them.
Let me pick up, though, on something. This is the Mario Einaudi Center. And as I've learnt, Mr. Einaudi's father was a governor of the Bank of Italy. So if we're going to talk about central bank independence, why don't we start with the Banca d'Italia, which, in many ways, symbolizes what really goes on with central bank independence. By the way, speaking of independence, you didn't tell me how long I'm supposed to speak for, so I will go indefinitely.
Anyway, the Bank of Italy has an interesting history, which I have a small amount of knowledge of, and I won't bore you with. But essentially, it has a culture and a role that is common among a number of central banks in countries with different economies. It was the repository of experts in economics and relatively uncorrupt people in a country where many policymakers were either inexpert or expert on corruption. And this took place in a country where, for many decades, fiscal policy, in particular, was seen as very difficult to make in a stable fashion.
And again, this isn't unique to Italy. You can look around many countries, not just in Europe. But in Latin America, in particular, you see central banks in this situation, whether it was in Brazil or Argentina, or you go to Africa, and you look at central banks, where whether it's the IMF coming in, the financial reporters, the people coming in, there is the sense that the central bank is the place of the sensible people, the honest people, the sophisticated people.
And even if they have absolutely no power over what's going on around them, they're the people the technocrats want to deal with. And this is understandable. But it also tells you something about the contingent nature of what central bank independence is.
Central bank independence is something you get when you have, I'd like to say, earned it. But let's at least say, you have built up a coalition in your society, that thinks it's a good idea. It's not a gift from God. It's not an inherently optimizing response. It's not something that usually comes exogenously. And this is where the politics of central banking comes in. It comes out of an environment.
And so when we think about the Bank of Italy, there are several interesting pieces of it. It's history that we can talk about in the context of the '70s and '80s, which were, in a sense, the period for forming the standard notions of central bank independence that are around today, both in academia and policy circles. So first is, in 1979, the Bank of Italy has what's called a divorce, divorce Italian style, from the government, that it had been like most other central banks during the Second World War, including the Fed, under legal constraint to essentially, buy as many bonds from the government as the government wanted.
All the other central banks, relatively rapidly after the war, at least in the major economies, backed away from that. Whereas, in Italy, it took a while. But it was seen, that by 1979, that had something to do with the inflation that was going on in Italy, that they would buy on request, on demand, anything the central bank-- excuse me, anything the fiscal authorities wanted. So there was a divorce.
And this led into a period of increasing European integration. And there were many people, some associated directly with the Banca d'Italia, some of them many friends of Banca d'Italia, who contributed to the idea that, well, if we actually give up more power to Europe, we will bind our hands. And then it will be more credible, whatever it is we're doing, and the local domestic political pressures won't get to us as much. We will be, in a sense, more independent to do the right thing if we're less independent by giving a power to the center, a concept I wish some of my friends in Britain understood better at the moment.
But you have this context, and then it grows up around it, a series of intellectual arguments, which I have referred to in the past as the Italian school of political economy. And such noted economists, as Alberto Alesina and Guido Tabellini, as well as a Swede person-- excuse me-- I forget his first name, person, and an Israeli, Albert Drazen, various of these people came out.
And the reason I called it the Italian school of political economy was not just it was centered in Bocconi, which is an Italian business school and a feeder to these places, but that it basically embodied this premise that you had to put in a new institution everywhere to bind the hands of government. And usually, you do that through an international agreement, possibly through a constitutional amendment, if necessary, through domestic legislation, because the real problem, the lesson coming out of the '60s and '70s, was democratic demands are too much. And when governments get too many democratic demands, they inflate. They bust the budget. They do terrible things. And that's what we need to prevent.
And that is, in the end, the model of central bank independence that later gets rationalized by Kenneth Rogoff, in his famous 1986 article, "Optimal degree of commitment to the intermediate monetary policy target," and the various things that came afterwards with Alesina and Summers, and Alex Cukierman, and various others. And for those of you who were not brought up in this tradition and not imbued with the '70s mentality, you may find this very strange. It sounds like, in some ways, a right wing coup. And in many ways it actually was.
But it was presented by the economics profession as a straight-up, Pareto optimization, that this overexcessive democracy pushing for inflation made everybody worse off. And because of this thing called time and consistency, in the end, you weren't saving one group versus another. What you were doing was just getting the whole society to be more patient, and everyone would be better off.
And this was a very powerful concept and extended to various other institutional arrangements around the world, and particularly, in European political economy, and obviously, to many central banks beyond the Banca d'Italia. But I think it encapsulates what the story was. And so that's what was going on in the '80s, into the early '90s.
And then you have the event that there is the Maastricht Treaty in Europe. And in part, because of this Italian school political economy and in part, because of political demands from German officials, the Maastricht Treaty says, everyone will someday have to be part of the euro. Exceptions will be made later. If you're going to be part of the euro, you have to have an independent central bank now or soon, and the central bank that runs the euro will have to be independent as well.
And that, then, is in a sense, the tipping point. So what had been an idea in New Zealand, in the Federal Reserve, in Switzerland, and most importantly, in Germany, suddenly becomes the norm. And it's not just the norm for Western Europe, for the members of the EU at the time. It becomes the norm, basically, for anybody who's setting norm.
So the IMF crowd, like various distinguished senior colleagues in academia who ran around the world consulting, various central bankers doing technical assistance, they all said, really good idea to have central banking independence. And ultimately, what was their proof? Well, the proof was twofold.
First, there were some very obvious, nasty instances of when central banks got overridden directly by politicians, and bad things happened. And this was true throughout the world-- Arthur Burns, overridden by Nixon and the US Federal Reserve in the '70s. At times, my friends at the Bank of England were accused of being the "chancellor's poodle," as the phrase went, in the political business cycles in the '60s and '70s. Obviously, the Italian record, and then to get more dramatic, you go to Brazil and Argentina and various others.
Now, about this time, and you, unfortunately, are subject to the one occasion on which I am going to be a really self-crediting old fart, in 1993, I wrote my dissertation. And I wrote a paper. Didn't finish the dissertation for a while. But I'll let your grad students pretend it's easy. Wrote a paper called "There Is No Institutional Fix for Politics," in which I said, central bank independence is not some thing that gets descended from God and just gets put in.
You got independent central banks prior to this fad, where there was a political constituency that liked the anti-inflation, that liked this arrangement. And therefore, if you impose this on various places where you do not have that political background, it's not going to work. Or at least, it's not going to work as well.
And two additional points I made at the time were that this premise-- and this I was too cowardly to really push, partly too cowardly and partly insufficiently skilled technically in mathematics. But I said, many of the claims that are made for the so-called time and consistency model, that if you put up inflation now, expectations will react. And you'll end up with higher inflation and no advantage, and the inflation will stay up.
Or if a central bank violates that, people will immediately react. And the inflation rate will go up, and the central bank will lose credibility. I pointed out, at the time, some things, that even among those central banks that were independent for a long time, like the German Bundesbank, like the Swiss National Bank, like the Federal Reserve, the economies did not seem to behave that way. And so I wasn't sure about this time inconsistency argument.
The final thing I pointed out at the time that was worth remembering-- I'm sure I pointed out a lot of stupid things-- was I said, by the way-- this is in 1993-- if the European Central Bank ends up being designed the way they say in the Maastricht Treaty, it will be the most independent and most autonomous central bank anyone's ever had, because it'll be guaranteed by international treaty. And so you can't put pressure on it. Someone, it might have been Jonathan Kirshner said this morning, something very similar to what I argued at that time, which was, if you were the Federal Reserve, you could call yourself independent.
But ultimately, the people in the senate can always change the Federal Reserve Act. So as the formal political scientist Susanne Lohmann modeled it, there's some cost to changing it. So you don't do it just trivially. But the threat is there.
And I saw this very viscerally. My first job after grad school, I was a junior economist at the Federal Reserve Bank of New York. And we were getting ready to do recruiting of the next year's economists. And suddenly, the directive came down. You can't interview anybody from a foreign country or at least, who's a foreign citizen still. Why?
Well, Congressman Gonzalez, chairman of the House Banking Committee, had hearings on the amount of money the Federal Reserve Bank of Minneapolis and the Federal Reserve Bank of Dallas spent on their new buildings. And then he's really mad. And we don't want to make him madder, so we don't want to hire any foreign people. And I was like, oh, that's interesting.
And it's just an example of the real world that the central banks live in. It's a very trivial example, but it shows you how finely sensitive even the Federal Reserve is to its legislative master. And so you put all this together. As much as I respected the individuals' working and running in these central banks, and there were ways in which the policies certainly seemed to be better in the independent central banks, this seemed to me much too pat, much too overrated, and most of all, much too denying the politics behind it.
All right, it's now 20, 23 years later. What happened out of sample, as we say in the social science business? Well, what happened out of sample partly supports what I said, partly doesn't, but generally, isn't great for the general framework of central bank independence.
The first thing that isn't great for the general effect of central bank independence is, what one finds if one looks at the data carefully, is that generally, you get central bank independence after inflation has been brought down in a country. It's not you get central bank independence, and that causes inflation to come down. Now, you can rationalize this in perfectly reasonable ways and say, well, that's because the central bank has to demonstrate competence. It has to demonstrate it's committed to low inflation, and that's when it gets independence.
But that's a long-winded way of saying that the central bank independence is more a marker of having successfully had, in the society, a coalition against inflation than a cause. It also turned out to be completely wrong, that consensus, because one of the side implications of this view that it's always forward-looking expectations, and central bank credibility matters a lot, was, as argued by Thomas Sargent and Robert Lucas and many others, was that if you had a credible central bank, diminishing inflation, disinflation, should be very cheap.
Because everyone believes you. If you believe in this time and consistency theory, once you realize that the central bank is going to take the inflation rate down, there's no point in fighting it. There's no point in raising prices. There's no point in demanding higher wages. You're just going to suffer. So you go right back down.
And this was repeatedly repudiated by the data, whether in cross-section or individual time series. You can go into it if you want. But this model didn't work.
It also was a little strange when we think about central bank independence. They didn't really have the knock-on effects people had. And this wasn't strictly part of the economics models, but it was part of the conversation, certainly in the setting up of the euro, certainly at the Banca d'Italia, and many other places. It was the idea that if you set up an independent central bank, it would induce other changes in the economy.
So in Europe, in euro land, rather, if you got a credible monetary commitment that you would not be bailing out the fiscal authorities, suddenly, Italy would become a neoliberal paradise. Suddenly, unions in France would become much less obstructionist. Suddenly, people's behaviors and expectations would change a lot. This did not happen. In fact, if there's one message you should take away from the euro crisis, it's that having an incredibly credible central bank that tries to tough it out and dare out the governments involved, it does not induce change.
I referred to this some time ago, long before the euro crisis-- I think it was in the mid '90s, mid-late '90s-- as the herring olive oil fantasy, that if you suddenly gave Sweden Italian institutions, you'd have olive trees in Sweden. And if you suddenly gave Italy Swedish institutions, you'd suddenly have herring in the Mediterranean. That was not going to happen. And it didn't.
Another point we're thinking about with regard to central bank independence is a contextual aspect of this. This is something that was discussed a number of times during our conference today, that these models and these assertions, understandably, to some degree, because of parsimony, overlooked this. But again, if you think about it historically, you get central bank independence emerging as the result of international fads or a record of low inflation or a new coalition. That's not a surprising.
But I had pointed out in a '95 paper, that central bank independence does depend critically on context. So during the hyperinflation in Brazil or in Russia, this independent central bank were very eagerly continuing to promote the hyper inflation. Because by that point, the banks had insulated themselves. Various other groups in society and the elites had insulated themselves. And doing the contraction, the anti-inflation efforts, would have been contrary to what the coalition was that was backing them.
And so again, in a sense, that's good news. We can salvage the concept of central bank independence. It's not all about just this one neoliberal, low-inflation attack. But it's also an important reminder that it is about the historical and the political context.
So in a sense, what I'm telling people, again, is there's no institutional fix for politics, that the institutions you have in your society do reflect underlying interest group pressures. And I'm sure for many at this conference and many in this room, that's not so surprising. But there has been this sense of purity about central banking that's denied that for many years.
And another way of looking at this, one of the social science aspects of this-- which, again, was discussed by some very good grad student papers this morning-- is the idea of, how do you measure central bank independence? So there was [? four ?] in the '90s-- I think we finally got rid of it-- but there was this cottage industry of coming up with various indexes of central bank independence. And you would code their prospects to, how long is the term of the governor? And how does the meetings work? And what's the legal status vis-a-vis the Constitution?
So Ken Kuttner, who's now a professor at Williams, and I did a little work on this. And we found that basically, none of these components individually had any predictive power for inflation. There were, essentially, two components that matter.
If you are a relatively rich country or in a democracy, a well-established democracy, basically going back to the divorce of the Banca d'Italia, if there was some legal barrier, like in Japan, that prevented you from being forced to buy whatever the Treasury issued, that was good for low inflation. And if you were a less-developed economy or a weak democracy, if the central bank governor got fired on a whim, that was bad for inflation. That's it.
And even turnover didn't really matter for the rich countries. And the barriers to the fiscal policy didn't really matter from poor countries, just these things, which, if you think about it, are quite political qualities. These are not some abstract technocrat things.
And so if you're thinking about this world, it is a world that doesn't look a lot like the theory-- not a surprise, perhaps. But it's worth thinking through, then what is central bank independence? Why do we care? Why is it so controversial right now?
So let me go from Italy to a couple of other examples. In the most recent issue of the Brookings Papers on Economic Activity-- it should be out within the last few weeks or right around now-- there are two papers worth noting. There's one on inflation expectations in New Zealand. And I apologize. I forget the four co-authors of that.
And there was one on Japan by Hausman and Wieland, in which I was the official discussant. And there were various virtues to these two good academic papers by young scholars. But the main point of both papers, I would argue, was that even when you had incredibly credible, transparent central bank policies, they did not have the expected effect on inflation.
So when you look at the New Zealand data, as these people did very seriously-- and I know we have a gentleman here from the Reserve Bank-- there is no convergence over time with long-term inflation expectations to the stated target level. Maybe it doesn't matter, because the inflation expectations are pretty stable. Might be true for policy purposes.
But it's kind of odd to have a central bank that's now going on, oh, I don't know, 25-plus years, of its inflation target, and stating, tattooed on the governor's forehead every month, the number is x, 2%. And there is no motion in the popular, polling data, and the financial markets data, anything, to get it to that number.
There's all kinds of bizarre things in the New Zealand inflation data. And it's not because New Zealand is a small country subject to inflationary shocks. The whole point of the regime is supposed to be, that if you do this credibly for a couple decades, at some point, people should notice. Doesn't seem to have worked that way.
May have produced good results, but that may be because an independent central bank is a more pleasant place to work. So some of the bright people who otherwise, would have left New Zealand, stayed in New Zealand to work for the central bank. Might have been because being an independent central bank, going back to an international aspect I haven't given enough importance to yet, is seen as a good housekeeping seal to the private markets, the same way the gold standard was in the 19th century, that New Zealand got less buffeted by capital market shocks. A lot of reasons why it might have done that, but it has nothing to do with credibility.
Then we look at Japan. And again, we have Hamada-sensei, and a number of ex-BOJ, and current BOJ people in the room. But I do know a little bit about Japan, so let me dare to go forward.
The important thing to know about Japan is Governor Kuroda comes in as the new governor of the Bank of Japan in, I guess, it's April 1st, officially, 2013. And he makes incredibly public and specific commitment to have the inflation rate to 2% within two years, which may or may not have been a good idea. But it's there.
He does so at the same time that there's turnover of the deputy governors and other members of the policy board at the Bank of Japan, which is then, in a sense, stacked to vote that way. Hi, Al. He has the full backing of the prime minister of the day, which ostensibly, should be bad for central bank independence, in some sense and therefore, make it more likely that it will be inflationary, whatever he does.
He announces a real commitment to the inflation targeting regime, that is the state of the art, at 2%. And the Bank of Japan finally starts buying longer-term assets rather than cash, which should have a bigger effect on inflation and expectations anyway. This goes on for two years. I completely supported it, publicly and privately. So did a vast majority of other monetary economists.
It probably was the right thing. But just as in Italy, just as in New Zealand, just as in the euro area writ large, it has almost no effect on expectations. You look at the survey data. They finally get expectations up above 0.5, but they stop rising, basically, after that.
There's almost no change in wage or price setting behavior, even though I and many others looked really hard to try to hope there was. And most recently, we've seen a series of negative shocks to the Japanese price level, including the energy price, including the small rise in the euro, in the yen, recently. And what's interesting isn't that this had an effect on short-term expectations, but that this drove down rapidly long-term inflation expectations, which says there was no credibility, no anchor, coming out of the Kuroda plan.
I feel very badly for the Bank of Japan and Governor Kuroda, because they've done everything right by the textbook. So I'm in no way criticizing them. But again, we're talking about central bank independence and credibility and this whole time and consistency model of inflation. The idea, that as credible a commitment to positive inflation as perhaps has ever been made by somebody starting near zero failed to work, tells you something about the nature of these problems.
So I think it's very interesting to think about central bank independence, therefore, as not being driven by this economic model and not having the effects people think, but as a political matter. And Jonathan Kirshner, earlier this afternoon, made a parallel that I think is very powerful, which is we're very accustomed in free trade, talking about trade issues as economists and political economists and political scientists and lobbyists, and say, OK, well, we know that there's this overall good when trade is expanded, generally-- some exceptions.
But there's also clearly the losers who vote for Trump, who are pretty mad about it. And we have to buy them off or ignore them or something and that we generally abjure talking that way about central bank monetary policy. Now, there are a number of reasons, politically and tactically, why you would make that choice, why you would decide, OK, if I can get away with it as a well-meaning central banker, and I can pretend that there's no distributional consequences and no political consequences of my action, or at least, they're not direct or not overt, I can do my job better. I can understand that.
And so it's fine for a sitting governor to try to keep this issue under wraps, and maybe be very careful, and not give speeches about inequality, say, because that draws attention to the fact that maybe you should talk about distributional issues. This has become harder in the era of quantitative easing. There's no reason it should. There's actually, frankly, nothing more unequal in terms of impact about quantitative easing, versus any other policy central banks have done, at least, not in any large sense.
But amongst us as scholars or wannabe scholars or pundits, let's stop kidding ourselves. Monetary policy is about distribution, as well, and even if it is useful and nice, to avoid it, talking about it. And again, this comes up very much in the issue of quantitative easing. And this is something where Paul Tucker and I both agreed and debated at various times and various people in this room have spoken about and faced.
So as was mentioned earlier, Ben Bernanke occasionally rejects the use of the word unconventional policy for quantitative easing. I was rejecting that from the very first speech I gave as a member of the Bank of England Monetary Policy Committee. I stood up, and I said, this is crazy. If you read any monetary history, central banks have been buying and selling private sector assets for their entire history.
Go back to the 300 years of the Bank of England. Go back to the 300-plus years of Swedish Riksbank. Hell, go back to that of almost any central bank except the Federal Reserve before the '70s, and you didn't have some nice, neat yield curve and some nice, calm, deep Treasury and money market. You were dealing in bankers acceptances and illiquid assets and giving winks and nods of the eyebrow to the discount window types.
It was messy. You got your hands dirty. And so there were a number of reasons why it was politically convenient and much nicer, as well as somewhat more predictable and efficient, during this beautiful period from, say, the early '70s in the US, maybe a little later, the early '80s in most other European and Japanese economies, where the central bank could play around with the short end of the yield curve by open market operations and take care of everything, and they didn't have to do anything messy.
But this was a historical accident of a particular period. And again, it's based on various, very strong assumptions about how markets interact, that the short end of the yield curve somehow prices everything out the rest of the way. And so I've said multiple times in the last few years, including at the IMF Annual Research Conference closing panel on QE last fall, if you want to be effective as a central banker from now on, you're going to have to get your hands dirty.
You're going to have to deal with specific asset classes. You're going to have to do buying and selling of quantities, rather than just play with the yield curve. And there are various, much more sophisticated arguments than I've made, including by my colleague Joseph Gagnon, and another former Fed official, Brian Sack, about how, for example, the Federal Reserve can still use the balance sheet in various ways, going forward, even if we get interest rates someday above zero.
There are many other sophisticated arguments you can make. But I don't think there can be clean hands. But if you can't have clean hands, and you can't have this fiction of clean hands, and you can't have this image of distance and mechanism, then the politics gets really bad. Because now it is like tax policy. Now it is like trade policy. Now it is like environmental regulation.
You may have a technocrat who's doing the right thing on both the cost benefit analysis and in terms of the mandate they were given by the legislature. But you also have lobby groups and populists and individuals coming after you. My good friend Eric San Juan is part of Meridian 180 and part of the people we're lucky to have in the US Civil service, said this afternoon-- or actually, you said it in the blog. Part of the job of bureaucrats is to keep the bureaucracy out of the funny papers. It's hard to do that when things are going badly and when you're goring particular oxes.
And so let me go back to-- we mentioned this earlier-- a comparison between the ECB and the Fed in this recent period of crisis. And to me, there are several interesting things. On paper, as I've mentioned, the ECB is actually more independent. And I forecasted this 20-plus years ago, more independent than the Fed.
Because in the end, whatever the fantasy is of Hans-Werner Sinn and Jens Weidmann and Wolfgang Schauble, they would have to reopen the Maastricht Treaty, which is an international treaty, in order to change the powers or the qualities of the ECB. Federal Reserve, you don't have to do anything, even the Constitution. It's just the Federal Reserve Act. A simple 60 filibuster-proof majority in the senate changes the Federal Reserve.
But it's very interesting. You have an ECB that was told repeatedly by leaders in Germany, by popular opinion in northern Europe, all right, all right, all right. You want to do something about the panic in the bond market. You want to do something about low inflation. Fine, but don't you dare buy countries' government bonds from the South. Because then you're bailing them out.
You want to buy private paper from French banks and call it an LTRO, OK. But don't you dare buy government paper of weak government. Then the Federal Reserve comes out at the same time and is told by the US Congress, oh, yeah, yeah, there's a panic in financial markets. There's terrible things going on. Whatever you do, I only want you buying government-guaranteed paper. Don't you dare buy something for the private sector, if you can avoid it.
An this is fascinating. OK, we're talking about the same quantitative easing, essentially, same crisis. And what's taboo in the euro area is completely different from what's taboo, the mirror image of what's taboo in the US. And we've seen this evolve.
So we were mentioning earlier today Article 13.3, which is the Fed's emergency powers to buy stuff. I'm using the word stuff consciously. I usually don't like to use the word stuff in academic environments, but stuff.
The whole idea was, if there's a panic, you want the central bank at appropriate discount, with some concern, worrying about solvency, yeah, yeah, yeah. But you want the central bank able to by whatever stuff you need to stop the panic. And what's happened repeatedly since the crisis is further and further constraint of what the federal ban is allowed-- Federal Reserve is allowed to buy.
And so now if, God forbid, we have another crisis, the Federal Reserve either has to hope that the Congress doesn't enforce what it's now passed, that essentially constrains the Fed from buying anything with government-guaranteed paper, or they have to let the system go down. Meanwhile, the ECB, while despite being all under attack, has powers to buy, essentially, anything it wants to-- very interesting development.
I'm not saying there's a clear answer here. I'm just saying politics matters, which is the central message of the conference. Similarly, Paul Tucker raised this in our discussions that afternoon. I was going to raise it now, so I'm glad to repeat it.
It's very interesting to think about this issue of what's called central bank capital. So as many of us have argued through the years, central bank capital actually is a fiction. OK? If the central bank runs out of capital to do its operations, it can print more money.
Now, it is a politically important symbol, because you don't really want to do that indefinitely. And so you want a government that's going to replenish the capital if, through good means dealing with the crisis, your capital goes down. And the great thing at the Bank of England, for example, was that the Bank of England up front had an indemnity-- and Paul can correct my usage of the words-- but had an indemnity from her Majesty's Treasury, which was affirmed by successive chancellors and successive parties, that if the Bank of England lost money as a result of it executing its duties in line with its mandate, Majesty's Treasury would automatically replenish this.
And this is completely different from the early days of the ECB and the crisis, when Jean-Claude Trichet repeatedly insisted he couldn't do things that most people wanted him to do, because, by God, the central bank would run out of money, run out capital. Why was that bad? Oh, well, we'd have to go to the Germans and ask for it, and then they'd have leverage.
Or the Federal Reserve, where, for politically understandable reasons, the independent central bank has been very skittish about what it does with its balance sheet, because it doesn't want to occasion too much congressional interference. And there are a number of these kinds of contrasts. And I don't think they simply map to anyone's notion of central bank independence or even measures of transparency.
They might map to long-standing political cultures. So it's very interesting to think about the fact that the Bank of England has had a less confrontational relationship, in my view-- and I think Paul said much the same-- with parliamentary oversight than the Federal Reserve. Now, part of this might be that parliament doesn't have much teeth in the same way that the Senate Banking Committee can really make life horrible for the Congress.
Part of it might be a cultural issue, that the culture of having permanent non-partisan civil servants, even if the Bank of England top officials aren't technically that, is respected in the UK in a way that it's not respected in the US. It might have something to do with written, versus non-written constitutions. I leave that to the political scholars in this room to consider.
But it sure as hell doesn't have anything to do but being caused by rules about central bank independence, with statements about credibility, with inflation expectation. It's hugely important for what the central bank gets to do, what its capabilities are, what policies it pursues. But it's not determined by all the central bank independence [? hoopla. ?]
So to put it in political science terms-- and I'm about 20 years out of date on my political science, so I'll ask my colleagues to forgive me-- but international factors matter a lot. Ideational factors matter a lot. And organizational factors matter a lot.
And Alan Blinder, actually deserves credit. He's done some of the few studies that are serious out there about central banks' organizations, about the structure committees. One of the things I love to do with visitors of the central bank nerd profession, which I was fortunate to have while I was at the Bank of England, was take them into the room where Paul and Governor and I and the rest of the MPC would meet.
Because when we met, we met in a small room. You had a four-sided hollow square with basically four seats on a side. You didn't have big name plates or anything. They were movable tables and chairs, because the room was used for other things occasionally.
And so you had the nine members of the committee. You had three staff who were there taking notes. And they never spoke unless asked a question. And you had a senior representative of the Treasury who also, similarly, was there to observe, occasionally ask a question. That's it.
As Alan and others can attest, the Federal Reserve Open Market Committee room is a little different. It's this enormous, long, narrow room. It has an enormous wooden stone, maybe not stone. Sure looks like stone to me-- anyway, enormous, very heavy table.
Each Federal Reserve Bank president and governor gets a big, bronze medal nameplate and chair. And there's three rows of senior staff. And the people who accompany each Reserve Bank president to the meeting, there's roughly 60, 70 people in the room to go with the people who are voting at any given time. It's a completely different organization. It's a completely different culture.
And for me, I would have been privileged in any event to serve in any central bank in a responsible position. I'm still grateful to have had that opportunity. But I felt particularly lucky to have been at the Bank of England, frankly.
Because the MPC, the way it ran was really not entirely equal colleagues. But broadly speaking, we were just a bunch of colleagues, who every month, over a two-day period, would really just discuss it. And the Federal Reserve Open Market Committee has a somewhat different dynamic. And I think the people who are governors there don't always enjoy it quite as much as I enjoyed being in the MPC.
Does it matter? As I used to say to visitors, I'd like to think, because we were able to deliberate, make mistakes, change positions, rather than read set pieces and be witnessed all the time, I'd like to think we had more intellectually stimulative, open-minded policymaking, or at least what policymaking there was actually took place in the Committee, rather than outside with a few other people.
I think that's an accurate statement. But I'm not sure the policy outcomes show that. It's worth thinking about.
So let me try to get this concluded. On a personal level, I made the comparison, or rather, I picked up on Jonathan's comparison earlier about making trade policy, say, for example, versus making monetary policy. I now am president of the Peterson Institute for International Economics. I'm very proud to have that role.
Fully a third to half of our staff and our output is oriented towards trade policy. So over the last three years, I've gotten to dive pretty deep with the US trade representative, Congress, counterparts in Japan, in UK, in Canada, in Indonesia, about trade policy. And often, I walk out of meetings about trade policy with an unclean feeling, wanting to wash my hands.
Because it's all about making deals in a very base level. It's all about even very good public servants who go off to negotiate, say, US-Japan bilateral auto parts talks. And all the economists and most of the trade negotiators on both sides know that this is really no good for either economy. And it's a huge waste of time, except for the fact that there are people in Congress, in the dyad, who will kill you and kill any hope of an agreement if you don't try to do something appropriate to pander to them, or at least, look tough, like you weren't giving anything away.
And there's just this enormous sense of farce, very hard-won, hardworking, well-intended, but still farce when it goes with trade negotiation. And there's an enormous sense of people coming in the door and saying to you, well, the most important thing is that there's a viable textiles industry in the US. And you can't say to them, you've got to be bleeping kidding me. You have to say, yes, yes, Senator, I'm really convinced that the viability of the US textiles industry is of critical importance to the US.
My experience in 25 years of consulting for central banks, and visiting central banks, and briefly being a central bank decision-maker, is you are indeed, at independent central banks, largely insulated from that. And I think that's true at the ECB and at the Bank of England, the Fed, Bank of Japan. There are, as I said, political pressures out there. There are things that matter.
But on the decision day, you can call it instrument independence. You actually do sit there, and you're largely debating with people about what you think the forecast is, what you think the effect of policy is, what you think the effect of your statement will be, what's the state of the world. And that's a very rare privilege in public service to get to do that. I know this isn't supposed to be a personal talk, but let me just say that for the record. It's a very great privilege.
And that comes down to what, in the technical speak, we would call instrument independence, that basically, central banks that are called independent really do get to set their policy week to week, month to month, maybe even year to year, on the basis of the technocratic argument, subject to the mandate they were given. And that's not about timing consistency models of inflation and credibility. If anything, having those debates probably does bad things to credibility and predictability in some ways.
And it's not because this was some God-given institutional design, to go back where I started. It's because you've won some sort of constituency in society that says, OK, we back this. And here's the rub. Here's where I'll end.
We are in an environment now where independent central banks are under greater attack than they ever have been, at least in 30 years. And interestingly, particularly for the Fed, surprisingly, the attack has come from the right rather than from the left. It has been the right saying, this is a central bank that has gone wild, that has outstripped its mandate, that is going after markets, interfering with markets. It's too powerful.
And it's particularly ironic, not just that this comes from the right, but that this comes at a time when there's a whole drumbeat of some justification from the markets. Oh my God, central banks can't deliver what they want to deliver. They say they want to deliver positive inflation. They can't do it. They said, they want to do. This they can't get it there.
And so if we want there to be central bank independence, you have to be willing to think about the independence of the institution and not necessarily the individual decision, which is a shame. So let me close by explaining what I mean by that. In formal terms, there was a very good paper by-- taking these people's names in vain earlier, but I'll give credit where credit is due-- by Alesina and Drazen, about 20 years ago, called-- oh, no, that's right. That's why stabilization is delayed.
This was by Drazen and Masson, my apologies, also 20 years ago, called, "Credibility of Policymakers Versus Credibility Policies." And it basically says, yes, it may be that circumstances say you've been doing this, this, this. You've been refusing to cut rates. You've been insisting on a particular forecast.
And it may hurt your credibility if you reverse yourself in this case, but it might help the credibility longer-term of the regime, if you don't do something stupid. This is Emerson's "a foolish consistency is the hobgoblin of little minds." But I think, in light of this conference and in the light of everything I said, I hope you'll take that also nonsensically, but as a political reality.
So just as the Supreme Court, at various times in the US, held off making a decision till it could get-- for example, in Brown v. Board of Education, it was clearly wrong to let the world stand the way it was. The Chief Justice and the majority of members of the US Supreme Court knew that. They did not make the decision on Brown v. Board of Education so they could get a 9-0.
More recently, I guess it's about 20 years ago, there was a key decision on abortion, where the middle of the Court at the time, Sandra Day O'Connor, Anthony Kennedy, and I apologize I'm forgetting the third relevant Justice's name, came out and basically said, whatever my personal views on abortion, I am not going to overturn years of precedent and discredit the Court in the eyes of the American people. So I'm going to vote to uphold this judgment against the aggressive anti-abortion law.
These are the kinds of compromises that independent institutions in reality have to do. And intellectually, that means independence means something a little different than what economists have sold you about central banks. Politically, it means you need some kind of statesmanship communication, going forward, if you want to do the right thing. Thank you very much.
So Hiro, I think you said I should take questions or comments or objections, if everybody doesn't leave at the break, which is very nice of them. Anybody? Please, Hamada-sensei.
AUDIENCE: Thank you. We first came [INAUDIBLE] here so I was thinking about the [INAUDIBLE] negotiation. They say that's transparent, but it's very hard to get [? info. ?] But [INAUDIBLE] about the helicopter money for [? new-- ?] many people are now advocating that we use stocks with some cash investment. Well, that scheme hasn't [? hit ?] [? here ?] [? just yet. ?]
ADAM POSEN: Yeah, thank you. I was very conscious, since I was already going long, I didn't include comments on fiscal monetary cooperation, which is obviously, at the heart of the helicopter money issue that Professor Hamada raises and is one of the most pressing issues of central bank independence. Before I respond to Professor Hamada, specifically, I'll just say, in general, I tend to be much less worked up about this than most people.
Again, it's the it's the idea of being pragmatic without being cynical. I think there's a lot of occasions on which some loose coordination between central bank and finance ministry or chief executive can be useful. And it doesn't automatically lead to a collapse of credibility or a problem.
What went on between Prime Minister Abe and Governor Kuroda, arguably, in the first half of 2013, I think is a good example. There are others. I gave a speech while I was still at the Bank of England, taking on some of the Bundesbank opposition to fiscal policy interventions in the euro crisis by saying, central banks aren't virginal creatures, that if they dabble in buying for public debt, suddenly their credibility goes poof, they're ruined forever.
But when we talk about helicopter money, specifically, for example, what's-- Adair Turner, I guess, has a new book, or relatively new book, talking about this and others, I actually there, I start sounding like a practical central bank nerd. I am not sure what the advantage is of calling something helicopter money, and drawing a lot of attention to it, and making it sound like it's something more than it is, than simply having a one-off or a short-term agreement between the central bank and the fiscal authority.
I'm not even sure it gives you any extra punch. As you've argued in Japanese context, and as many mutual friends of ours have argued-- you didn't argue for helicopter money. I'm saying something else. Don't worry.
As many mutual friends of ours have argued in other G7 countries, there's a lot of room when interest rates are this low to do fiscal policy. And it may not even need helicopter money. It may just need a central bank that doesn't increase rates rapidly if you do infrastructure spending.
In addition, if you get outside US or Japan, and specifically, you look at European central banks, for example, there are issues of what's called the state aid rules, that are there for good microeconomic and political reasons in a European context, that you don't want to violate overtly. So I think there's a lot of room to do agreements on fiscal policy and monetary policy, or, more accurately, for be it Japan or US to do fiscal expansion along lines you've advocated, and the central bank to accommodate that. But I'm not sure doing something called helicopter money doesn't just make it less effective and more politically dangerous for no good reason.
AUDIENCE: That'd be my take.
ADAM POSEN: Yeah, please.
AUDIENCE: I agree that there so many combinations of monetary and fiscal policy. Even though both are quite effective, both fiscal and monetary policy are quite effective, but there is no way, always tight for [? MES. ?] So I agree with you.
ADAM POSEN: Thank you. Just another point for the political economy, political science, and other fields in the room, again, if you come out of this Italian school tradition I talked about, or the formal political economy/economist tradition, which you can attribute to either Persson and Tabellini or Buchanan and Tullock or whatever lineage you want, you would be very surprised to look around the world now and see all these countries where people are reluctant to engage in fiscal spending.
Now, some of the hard-boiled people of this ilk will tell you, oh, my God, no, but look at the deficit. Things have gotten out of control. But really, controlling for the business cycle, that's not true.
What we've seen time and again is fiscal financial ministries, finance ministries, basically saying-- again, in the rich world and the rich democracies-- no, I really don't want to spend the money. I'm going to do everything possible to keep from spending the money, whether it's Tim Geithner in 2010, the Ministry of Finance, at every possible point in Japan, certainly, the German Ministry of Finance in Europe or the Dutch Ministry of Finance.
So again, in the same sense that I've taken on intellectually, I hope, central bank independence is an example of mistaken political economy or misplaced political economy, I think it's a good topic for people to think about also on the fiscal side, that there's ideation on matters, there's international fads. There are other things going on rather than the standard model that came out of the '70s, that democratic governments always spend themselves into oblivion.
AUDIENCE: Lourdes Casanova.
ADAM POSEN: Sorry, I want to-- OK, you got it. Sorry. OK.
AUDIENCE: So I'm academic director of Emerging Markets Institute here at Johnson. So my question is, how do you think China is influencing the politics of central banking? China is invading the world with products and services at very cheap price, so somehow influencing inflation in Western world, and more and more, giving [? launch-- ?] Brazil, Argentina, Venezuela-- at very cheap rates, cheaper rates than the rates that are fixed by the central banks of those countries. So how do you think China, with these unorthodox policies, is influencing the politics of central banking?
ADAM POSEN: Well, I'm less sure that China is influencing things through its unorthodox policies than simply by its size. And I think that actually is a distinction that matters. So there's a paper that recently came out by three very good empirical trade economists. It's gotten a lot of play-- Autor, Dorn, and Hanson.
And it documents that there was a period in the early 2000s when, contrary to what pro-free trade advocates would say, or expect, let's say, that there were some people that US manufacturing industry really got hit by low-wage, low-cost Chinese products, and that most importantly, a bunch of workers who lost their jobs in that process were unable to find new jobs, at least, not within a reasonable length of time.
And they do their repair work very well. And I don't think there's much to dispute with their results. We can talk about its trade implications on another occasion. But what I think is interesting about the results is, it really does apply to China in a very specific period.
It wasn't true when US did NAFTA. It wasn't true in earlier periods with China or the coming on of the Eastern Europeans into the world markets. So in a sense, about your point, there was some there was a specific China shock that was very low wage, very low price, very large size, that the US and the other-- and everybody, Brazil, Argentina, as well, had to cope.
And so in a sense, we should have been better about handling it at the time. But in another sense, we're kind of past, if you look at the same kind of data, that China has-- or large parts of the Chinese economy, let's say, have moved far enough up the value chain, and wages have increased enough in China, that you're not getting the same kind of thing.
Now, there are specific cases where you are. They're obviously dumping steel on the world market, OK? And this is hurting a lot of people. And for all by yammering about not wanting to pander to trade policy, if you were ever going to imagine a circumstance under which anti-dumping rules might be useful, it would probably be steel right now from China. OK, so I mean, there are things you can talk about.
But I actually don't think of that as the major driving force on the monetary side today. And in particular, you mentioned the issue of loans. And it's a very interesting issue. And actually, our institute's releasing a set of studies later this week on Thursday. And again, everyone can watch the webcast, download them for free, just like here at Cornell at the Peterson Institute, www.piie.com Wow, nobody laughed. The world is a changed place.
Anyway, and we're looking at the One Belt, One Road Initiative, or the Belt Road Initiative, or the Silk Road Initiative, whatever you want to call it. And it's clear that the Chinese are going to pump out loans to a lot of places at very low rates. It's also clear that the amount they've pumped out so far is tiny.
Now compared to the size of even the economies of Brazil and Argentina, it's tiny. They haven't done that much additional lending. There's one project in Pakistan. That's it. That's the only thing that's actually gone through this program.
And so I think it's there. I think it has distortions. I think the recipient countries have to think hard about what they're going to do with the money, but I'm not terribly worked up about the Chinese role in this right this second. Back to the left.
AUDIENCE: I don't know [INAUDIBLE] you could offer some reflections on comparisons between central banks and [INAUDIBLE] or constitutional clause. So if you think about that the base [INAUDIBLE] century just as Sloan's comes out and says, well, we're not actually reading the law. We're bringing our own values to it.
And then through the critical legal studies, which was quite a long moment, that's-- gets slightly over-excited, and they yelled, literaturists, just go way. And actually, we're just making it up as we go along. There is no restraint in this. There's just politics.
And if you sit where I do in the world, probably in the middle of all the [? notions, ?] this ends up with Gore versus Bush, where it just splits. It's the worst nightmare of what it is to have unelected power that then serves partisan purposes. And I would say that, by the way, whichever way [INAUDIBLE] got, it has nothing to do about the result.
And I worry that when people talk about the [INAUDIBLE], that central banking is fused with politics, we need to be very careful to say that's not the same as saying, it shouldn't be insulated from day-to-day politics. And judicial restraint seems to me to be a virtue in a democratic society. And central bank restraint is a virtue, I would argue, in a democratic society.
So whilst I completely agree with you that central banking can't be pristine, it seems to me that it should be parsimonious, consistent with achieving the objectives it's being given in the real world. But I really want to hear whatever you want to say about those parallels.
ADAM POSEN: Paul is being very gracious. That's Paul Tucker, as many of you know, former deputy governor of the Bank of England. And he has thought about these issues very deeply. I know, over the last few years, he and I have had some exchanges about these kinds of issues.
For the real political science junkies, there was a while we were going back and forth on whether Sam Huntington's, The Soldier and the State was applicable to the behavior of central bank governors. But let's stick with the Supreme Court for now.
I probably don't have anything that sophisticated to add to you. And certainly, I know a number of friends here who are legal scholars. But let me just take you up on the practical implications of what you said.
I think it is exceedingly difficult now, post Gore v. Bush, post a number of the decisions made in the last 10, 15 years, Clarence Thomas remaining silent for all but two days on the bench, Antonin Scalia's, let us say, checkered record. It is extremely difficult not to be cynical or to be [? fancying ?] critical legal studies about the Supreme Court.
And what's fascinating is there's a new set of articles, which were probably well known in the legal scholarship, but only making their way out to us, the broader pseudo intellectuals, recently about Felix Frankfurter, who was supposed to be this great justice, and who went on the FDR Supreme Court, and actually just pandered, pandered, pandered in a very cowardly way. So I think you've actually put it very much right, which is, can you do things to insulate the institution? And are there self-restraining behaviors that the decision-makers and the institution as non-elected people should undertake?
And I think having that kind of ethos and having that even made a statement of conduct, I think it's very helpful. I think there are limits to what you can do. On the other hand, I think these institutions are surprisingly resilient.
I used to say half jokingly, with apologies to my friend Tatsuya, that I was amazed people didn't burn down the Bank of Japan in the '90s and early 2000s. No, seriously, I mean there were spikes in suicides in Japan as a result of the deflationary policies pursued by the leadership of the Bank of Japan. And nothing happened to the Bank of Japan
There's a lot of security at the ECB right now. And I would not want to be sitting in Mario Draghi's shoes. But realistically, nothing has happened to the ECB. And you could say the same thing about bankers, about a lot of things.
These institutions are surprisingly persistent. Or maybe for political scientists and anthropologists, they're not. But for policy wonks, they're surprisingly resilient and persistent.
And so you look at the US Supreme Court. You can go back to Plessy v. Ferguson. You can go back to Dred Scott. You can go back to outrageous decisions throughout the US political history. And yet the Supreme Court goes merrily on.
And so then you have to ask yourself, is that because the institution only deviates that badly occasionally? Is that because it really is an on-average swing with the political winds, so you can't realistically expect better. I don't know.
But when it comes to central banking, again, for what it's worth, just a personal opinion, is very similar to where I think you just articulated, Paul, and I'm sure you've written and developed further in other places. I think self-restraint is very important. I think-- this goes to a discussion we had in the last session of the conference-- I was sort of pooh-poohing overemphasis on communication. But you and others rightly pointed out that the importance of communication may be going through the exercise visibly of being accountable to people.
So as you know, when I was at the Bank of England, I did an enormous number of going around to individual little pubs and schools and businesses around the UK. I mean, I think there was a little bit, "he's the American. He'll think it's cool to go to Skegness. Let's send him." But later, I think I counted up. I think I met with, counting everybody, 17,000, 18,000 people over the course of my three years.
And I think that was very important symbolically, especially for me as a foreign citizen sitting on the MPC, to say that I'm accountable. So I think all these kinds of things matter. And I think the kinds of things that Greenspan and Volcker said about lack of transparency and patting themselves on the back for being untransparent should have been bad at the time, and you certainly can't get away with now. So I think there's a lot of that.
But I'm going to say one other thing. And this is one pol that may not be pleasing to you or may not be pleasing to certain people we know. Another piece of this, it seems to me, is central bankers should shut up about policy that's not really in their remit. I am really sick of central bankers, whether it is Bank of England, European Central Bank, Federal Reserve, going out there and commenting on fiscal policy, on Social Security. It's not their remit.
And they can play this game and say, well, ultimately, it has some effect on price stability. And this goes back to, again, to the Banca d'Italia problem or the Reserve Bank of South Africa problem, or whatever. If we're the only non-corrupt, competent people here, we feel a duty. We have to be the ones to talk.
And I remember I said this to a group of African central bankers. I said, I really think this is a bad idea. I think it asks for trouble. You have to restrain yourself, even if you know the people in charge are doing something stupid.
And they were all over me. They were like, you're such a naive. In our context, mistakes are disastrous. And everybody looks to us for being the only experts, the only relatively unbiased people.
I think it's a fair debate, but I think, even in a US context, where you could argue there's a great deal of political deadlock and incompetence, it still would be good if the Federal Reserve never talked about things that weren't narrowly in its mandate. And again, to be nonpartisan, I don't think Alan Greenspan should have ever been opening his mouth about fiscal policy. And I don't think Janet Yellen should have given a speech on inequality. Yeah?
AUDIENCE: Thanks for that. Just on the fiscal New Zealand--
ADAM POSEN: Yes.
AUDIENCE: --so just having those inflation expectations, and they are around 2%, which [? was ?] [? low, ?] so they have [? moved. ?] But there's no doubt that they are [? a bit ?] [INAUDIBLE] and rational when it comes to the general public. But the professionals have those almost perfectly rational expectations amongst the professional community.
I want to take you to task, though, with your characterization of consistency issues in relation to central bank independence. The famous time consistency [INAUDIBLE] in the '80s, and Barro and Gordon, and all the others that were around at that time, were all independent central banks with two targets-- a real or common target and an inflation target.
And the issue wasn't central bank independence or not. It was having two targets that was the problem for a time consistency. And any independent central bank with [? muliple ?] targets [? had ?] a time consistency problem. And that was what we broke in New Zealand when we went to single inflation target, a year-round time consistency problem.
So independence isn't about-- independence with inflation and time consistency aren't the issue. It's single-target [INAUDIBLE]. Now our problem [? within ?] this [INAUDIBLE] is we need another counterfactualist. So you're saying [? then ?] [? it ?] has [? maybe ?] effect, because we don't know what the effect has been, because we never see the counterfactual.
And that's the same for people that are opposing the [? banks ?] and mostly support independence. And we're not microeconometricians, unfortunately. But let me give you some examples. So before New Zealand [INAUDIBLE] independence, we had a three-year election cycle of monetary policy. Every third year, monetary policy was expansionary for over a period of 20 years.
Once New Zealand Bank became independent, there was no three-year election cycle ever again in monetary policy. Shortly after New Zealand Bank became independent, the fiscal-- the new government at the time said, this is terrible-- because of the [? single payment ?] of central bank, if we run an expansion of fiscal policy, the exchange rate will go through the roof, because we have to borrow so much.
And the minister of finance at the time, who was the only responsible one, said, well, that's what gave the central bank independence. And therefore, we have to [? mind ?] [? our ?] responsible fiscal policy. And actually, so the [INAUDIBLE] went from [? China ?] being a fiscal leader to becoming a monetary leader. So in other words, the central bank independence disciplined the fiscal authority [? was ?] [? before ?] being the other way around. So I take issue with your precluding the central bank independence of having any effect. I think it did, but neither of us can prove it.
ADAM POSEN: Well, actually, no. I think I can prove you're wrong. So let's just go right to it. The question, as I said, the reason I went back to my '93, '94, '95 papers was not just simply my ego indulgence, although, of course, that was the main motivation. It was to say that I made predictions that were true out of sample, that there were a bunch of predictions that were being made in the central bank independence literature, based on the New Zealand experience and based on the scatter plots of Alesina and Summers in the JMCB in 1990, and they didn't come out right. And I predicted they wouldn't come out right, and that's what happened.
AUDIENCE: There are a number of [INAUDIBLE] in this [INAUDIBLE] and [INAUDIBLE] in the late '80s. We predicted there wouldn't be any more electoral cycles [INAUDIBLE].
ADAM POSEN: So the question is--
AUDIENCE: [INAUDIBLE] like the Asian financial crisis and the global financial crisis, and things like that. You wouldn't give the [? Israeli ?] [INAUDIBLE] what it had before.
ADAM POSEN: But again, if you want to argue that New Zealand had that impact, then all you've got is a one-time series observation. And I can probably do a bunch of archival and other political examination in New Zealand and come up with a bunch of other explanations for it.
If you look cross-sectionally, cross-nationally, panel data, for example, on political business cycles and political monetary cycles, which were done by scads of grad students who didn't know better throughout the '90s, you find that, for example, Germany had an independent central bank. And as Susanne Lohmann discovered, there were huge political monetary cycles. There was no change in the political monetary cycles before and after central bank independence in several European countries, including UK and Italy.
So again, you've got one-time series, which is one observation. And therefore, it may just be something idiosyncratic to you wonderful New Zealanders. None of the stuff holds up out of sample. None of the stuff holds up cross-sectionally. So if you want to call that evidence, you're entitled. But I don't think it's right.
ADAM POSEN: No, you don't. All you've got is one observation.
AUDIENCE: You're just talking generalities, and I'm talking specifics.
ADAM POSEN: No. Last I checked, econometrically, a one-time plot for one country is one observation. And if you don't think that it can transfer out of sample or across countries, all you're doing is saying, the dummy variable-- if I put in a New Zealand dummy in that cross-section, that wouldn't absorb all the other information.
AUDIENCE: [INAUDIBLE] can apply. So if you want to talk econometrics, we can talk econometrics. But what I'm just arguing that your-- neither of us can prove [? that ?] independence was actually definitely effective or not definitely effective, because we don't know what the counterfactual is.
ADAM POSEN: But we do know what the counterfactual is, because we know that there were countries that didn't have independence and then were given independence with very little change. And we know that there were occasionally countries that had violations of independence.
ADAM POSEN: Oh, I didn't even bother with your nonsense about multiple targets. All right, let's go back to the--
AUDIENCE: --can't get your theory right because you can't prove that it occurred.
ADAM POSEN: No, no, that's actually getting the theory right interferes with properly interpreting the empirics. That's what the theoreticians always did. So let's go back to Barro and Gordon, Kydland and Prescott. So they set up this two-variable thing and the whole thing that was there. And then if you go through those things-- and I'm sure you have many more theoretical publications than I do. Let's just go to the essence of it.
The essence of it is simply that there's a trigger there, that expectations will jump if they're violated, if there's a change in regime or a surprise. That is demonstrably false repeatedly. That does not show up in any data for the US, for the UK, for Italy, for anybody. Maybe it shows up for New Zealand. I don't bother looking at New Zealand data. But the fact remains, it's not there.
AUDIENCE: --time consistency papers of the time, which was interfering with [? my ?] purpose.
ADAM POSEN: Yeah, but the time consistency papers at the time were pure theory, Kydland and Prescott's 1979, Barro and Gordon's 1983. Then we get a bunch of people who actually believed the theory because, ideologically, it suited the idea that the bias against inflation wasn't reflecting a particular right-wing association. It was something that was Pareto and proven, and that the problem with democracy wasn't that we couldn't get agreement. It was that the wrong people were asking for too much.
And the problem with the '70s wasn't that we had mismanagement on the fiscal side in a political sense. It was that the central banks were too weak. This was an ideological agenda. And so then everybody took Barro and Gordon and Kydland and Prescott and said, gee, I'm going to take that forward. And that's how I'm going to get this whole agenda. And I'm going to have this institutional political economy.
And it failed completely in Europe. And it has failed repeatedly in Brazil and Argentina. And it has failed in India. It has failed in Nepal. And it has failed in Eastern Europe, and it has failed in Russia. So maybe the New Zealand dummy, in my cross-sectional regression, says there's something magic about New Zealand. But that theory is wrong.
HIRO MIYAZAKI: There's another question [INAUDIBLE], the final question.
AUDIENCE: So I'm John Cisternino, the director of research with the Tobin Project, and I love this exchange. I guess I had a further question about the thrust of your remarks this evening. So you've critiqued the evidentiary basis of thinking that central bank independence matters in the ways that people have said that it matters.
But at the end of your remarks, you had us [? conventionally ?] in mourning about the potential loss of central bank independence. And so I guess I was wondering, in the spirit of us being a great university, why is it that it seems to you as reasonable-- so the things that we should be trying to learn [INAUDIBLE], that we understand how to make central banking better for poor countries and for the world?
Is it that we need better data to see the ways in which independence might actually matter, or that we need to be slicing the salami differently so that some of the political culture elements that were driving the positives of deep independence but were not there and you merely got legal independence mattered, or something totally different? But I sense there was something more than just the pleasure that bureaucrats got from getting to interact in a deeply independent place that was driving your sense, at the end, that something valuable might be under pressure. And I was just really curious where we ought to be looking to be able to build a strong [? adventure ?] [INAUDIBLE].
ADAM POSEN: I'm sorry that I was unclear on any of this and that I gave contradictory feelings. Basically, I associate myself very strongly with the remarks by my colleague Paul Tucker, that I think it is mistaken-- and I'm probably stronger, if anything, more on this wicket than Paul is-- to pretend that central bank independence is particularly clean, pure, or whatever. Although, Paul doesn't adhere to an extreme version of that by any means. But I think you look back to the history of central banking, there's a lot more politics, in the general sense, behind the way these institutions developed when so-called independence emerged or didn't emerge, how it was used.
And so as an intellectual exercise, in a sense, what I'm giving is impetus or agreement to what I understood from the conference organizers to be part of this conference-- that isn't why I'm doing it, but I happen to be doing it-- that as a dependent variable, if your dependent variable is either central bank behavior or form of central bank institution, there are some political, social, cultural, [? ideational, ?] if that's the right word, factors that are determinative of that, and it's not a technocratic fix. And so it's an intellectual pursuit. If you just want to understand some of those variables, you need to broaden your set of explanatory variables. That's the first thing.
The second thing is, from policy perspective-- and again, I think Paul's discussion of the Supreme Court and my attempt to respond to it, I think is on target, I hope, and some of the things Alan has written about in the context of committees in some of his more popular books-- you have to not leave it to the institution. What matters, in the sense, is conduct.
Conduct actually matters. It doesn't save you, necessarily. If John Taylor gets the ear of President Cruz, you're going to have a really bad monetary policy and probably some really terrible recessions because the removal of discretion for a very tight monetary policy rule in the Federal Reserve would be a disaster. But that's not-- to some degree, that's out of our control.
But to some degree, I think if central bankers are restrained in what they do-- and it's just like you talked about conduct of generals who report to political overseers, or Supreme Court justices, or other judges who are appointed for life, you try to at least give not just the impression but the behavior of someone who is not terribly motivated by partisanship or short-term motivation. You try.
And part of the reason I think my remarks may have been confusing or unclear is because I was spending a lot of my time attacking the economist notion of independence, which to me, had too much pretense-- and it's not all economists, but the economists of that ilk-- pretense of neutrality and that the institution was neutral. And it's actually about how the individuals involved conduct themselves, I think, matters a lot.
And so let me just give you one final story. Three years ago, almost four now, literally my last day as an official at the central-- I wasn't even an official. I was a voting member of the MPC at the Bank of England. I was speaking at the Fed's Jackson Hole conference.
And I was asked to discuss a paper by the brilliant Michael Woodford on what was called "forward guidance." And it relates to what we talked about today. And I had two encounters that went with that.
First was I stood up, and I said-- I thought nicely, but probably not-- forward guidance is really stupid, because you cannot make a commitment that you're not going to do something in future and not respond to data. And if people just listen to that, they're just going to focus on your every little move and it's just going to be bad and again, out of sample, despite the fact that the theory was beautifully elegant and based on timing consistency and forward-looking models, and all this stuff, out of sample.
The disaster of Mark Carney's forward guidance policy at the Bank of England, I predicted. OK? The other thing was a conversation I had with I won't name who, but two of the people who would be on the short list to be Fed chair if a non-Trump Republican won the election. If Trump wins the election, who the hell knows? He may blow up the Fed. I don't know. No, I'm serious. I have no idea.
ADAM POSEN: Yeah, for Trump. Yeah, that's me. Right, OK, there we go. Anyway, so I had conversations. I won't identify the people, but with two of the very heavy hitter, academically credible individuals who would be candidates for Fed Chair under a normal republican. And they both said to me, Adam, you were really advocating that you buy more stuff and that you buy all different kinds of stuff. I said, yes.
And both of them individually said to me, I think that's a bad idea, not even necessarily because I disagree with you right now, but because that will undermine the independence of the Fed. There are people who won't stand for it. And ex post, they turned out to be right out of sample.
Now if I was sitting at the Fed at that time instead of the Bank of England, I honestly don't know how I would have reacted. Part of me would say, OK, Adam, you've been talking this game about the political constraints on independence since your dissertation. And you've cited Drazen and Masson and all these things about being willing to trade off short-term policy for long-term viability. Maybe they have it right, and you should just shut up and at least, back off.
And then there's another part of me that said, if this was just something small, I wouldn't worry about it. 2012, things we're still not yet great. It wasn't quite as bad in the US, thank God, as it was. But the euro crisis wasn't yet resolved. Things were still pretty bad.
And part of me would say, well, the whole point of independence, whatever we call it, is to do the right policy, what you believe to be the right policy, irrespective of political leaning. And so I have honestly agonized over that hypothetical for a long time. And I was thinking about it again as I prepared my notes for this speech. And so I'm grateful for your question, because I got to work it in.
I think that illustrates the realities. And part of me says, well, maybe if the Fed had been more circumspect or said different things, maybe it wouldn't be in such a mess right now. My strong suspicion is, though, that's not right, that the backlash against the Fed has more to do with our failure to address inequality, in particular.
And it's more to do with certain cultural things, that I don't want to spell out, but that many of you can guess about how the people who vote in the right wing of the Republican Party view central banks, and a general tone of distrust of government institutions. And so part of me says, no, you had to do the right thing anyway, because of A, it wouldn't have matter, and B, you have to do the right thing.
But again, that just gets us back to it's not about the institution on paper, and it's not about the time and consistency model. It's about the conduct of the central bankers and the political context in which it takes place. Thank you very much.
HIRO MIYAZAKI: Thank you very much, Adam, for that provocative presentation, based on really his rich personal reflection, really thoughtful reflections on his experience. And so his lecture here left us with lots of questions that conference participants could argue about tomorrow morning in a closed door. And for those of you not formally participating in the conference, tomorrow evening at 4:30 PM, we have 2016 [INAUDIBLE] lecture, to be given by Professor Alan Blinder, who just arrived just in time for this lecture.
So I hope to see many of you there. The lecture will take place in the Statler Auditorium. And it's a big event for not only the Einaudi Center, but also for the entire University. So we are expecting a huge crowd. So thank you very much for coming, and have a good evening.
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Adam Posen, president of the Peterson Institute for International Economics and former member of the Bank of England's Monetary Policy Committee, discussed the independence of central banks April 18, 2016, as part of the Foreign Policy Distinguished Speaker Series and the global conference, "The Changing Politics of Central Banking," held at Cornell on April 18-19. The event was organized by the Einaudi Center in collaboration with Meridian 180 and the Global Finance Initiative.