Mojmír Hampl, Vice-Governor, CNB
Prague Conference on Political Economy
Prague, 18th April 2015
Let me start by saying that it is a great honor for me to participate in this conference and to be the first speaker in this interesting session. Needless to say it is an utmost pleasure to be here especially with William White and to have him as a co-discussant.
Our topic, the challenges that the recent crisis brought for monetary policy, is both attractive and challenging. It is attractive because monetary policy is a key segment of economic policies in any standard market economy. It is challenging because there are actually numerous lessons that the crisis and its repercussions have taught us (Akerlof et al., 2014, Fischer, 2015).
From my viewpoint of a practicing central banker, one particularly dominant lesson emerged right at the outset of the crisis. As the crisis subsequently unfolded, other aspects took center stage in public debates. Nevertheless, I still consider the initial lesson for monetary policy to be the crucial one.
The lesson I have in mind is that inflation targeting as the monetary policy framework which, in an explicit or implicit form, prevails in the developed world, needs to be made more sensitive to asset prices and property prices in particular.
To see the issue more clearly, let me, for a while, go back some ten years. Around 2005, the process of the so-called Great Moderation reached its final stage: in most of the civilized world, inflation was low and stable, output was growing at a satisfactory and stable pace, levels of unemployment were mostly acceptable, consumers were enjoying the fruits of globalization, and governments – as irresponsible as they tend to be – were running deficits without their debts facing significant roll-over risks. Central bankers were basking in fame and esteem. The camp of inflation targeters, while already fairly populous, was still growing (Jahan, 2012).
In 2007 the dark side of this monetary policy nirvana started to emerge: it became clear that in at least some countries, the low interest rates that were needed to keep inflation in the vicinity of inflation targets, were fueling very unhealthy undercurrents in asset markets. The most striking example of this phenomenon was, of course, the seemingly permanent sizeable rise of property prices in the US, but also elsewhere. This rise led to excessive proliferation of mortgages, especially in the so-called subprime market. Once the upward trend in house prices stopped, the unsustainability of the previous developments became clear and the financial crisis began (Financial Crisis Inquiry Commission, 2011).
With each new piece of bad financial and economic news, especially following the post-Lehman turmoil, there were more and more observers arguing that the pre-crisis monetary policy was actually far from estimable – on the contrary, it was deeply flawed.
The harshest remarks called for a complete overhaul of the very logic of contemporary monetary policy. Specifically, in libertarian or right-wing circles which – I guess – are well represented here today, a popular suggestion once again has been to go back to the good old Gold Standard (e.g., Shostak, 2012).
A certain paradox seems to occur when people who argue for market-based exchange rates and a free-floating FX regime also argue for the Gold Standard, which is a particularly rigid kind of mechanism that requires permanent fixing of a very important price in the economic system to the price of gold. Here, I assume, it is about the old dispute between the neo-Austrians and the Chicago school, or monetarists.
But even leaving this paradox aside, a return to the Gold Standard does not seem a good idea from a macroeconomic point of view. Past experience shows unambiguously that this particular monetary policy regime tends to produce rather high output volatility – much higher than later regimes (Bordo, 2007). One of the reasons is that it works like an exchange rate peg: it induces authorities to postpone nominal adjustment until the size of the necessary adjustment is too large to postpone anymore and then the adjustment is implemented with a big splash, similar to jumping off a cliff instead of walking down step by step. This is not in line with the desire of many to have cycles that are more rather than less smooth.
The criticisms I feel more sympathy for are less revolutionary: they stay within the broad boundaries of the current monetary order, which is based on fiat elastic money without intrinsic value being produced both by the central bank and by commercial banks. And we can frame it in the usual regime of inflation targeting.
The first group of critics is calling for some important changes to how this system is implemented. One, rather technical stream of literature points out flaws in the way a typical central bank constructs its inflation forecast as the basis for its monetary policy decision (Thoma, 2015). It goes without saying that any central bank worth its name, and certainly the Czech National Bank, keeps looking for ways of improving its analytical and predictive apparatus. But here, as always, we face the difficulties of insufficiently long time series, many structural breaks, many crucial but unobservable variables, and so on. Last but not least, we struggle with the tradeoff between the comprehensiveness with which the model covers the various parts and traits of the economy and, on the other hand, the model’s tractability, transparency, and intuitiveness. But attempts to integrate the financial sector into the standard models seem to be rather promising.
A different group of critics focuses on the objectives that monetary policy should be concerned with. Here, I gladly point out the contribution made to this debate by the Bank for International Settlements – not only because we have Bill White as a member of our panel, but also because the intellectual contribution of the BIS has been very important here and it remains so. In a nutshell, the BIS has been urging monetary policy makers to take into account in their decisions developments not only in the real economy, but also in the financial sphere and to take into account more prices than just those included in the standard consumer basket (for example, BIS, 2014).
At one time last year, representatives of some central banks actually lost their nerve a bit and tried to attack the BIS “ad personam”, so to speak: they were saying that if an institution is not itself responsible for the actual conduct of monetary policy, then its advice is not worth much. I do not share this view and I have defended the BIS in an article for Project Syndicate (Hampl, 2014). One should not forget that the BIS was one of the first to warn of the dangers of financial excesses, several years before the 2008 crisis. I highly appreciate the input that the BIS and its first-rate research and analytical documents provide us with, even if I may sometimes come to different conclusions than the BIS does.
But let me return to the issue of what objectives should be pursued by monetary policy. I fully agree with the general notion that the focus of pre-crisis monetary policy was too narrow and that monetary policy should become more sensitive to financial sector developments. But this notion can be operationalized in various specific ways.
One way which I think is particularly promising and intuitively acceptable is to broaden the price index for which we set inflation targets (Hampl, 2011). More specifically, we might accept the previously rejected view that home purchases are bought primarily for consumption. We would thus stop drawing a dividing line between property (and perhaps certain other) prices and the prices of consumer goods and services. When we are buying a house, apartment or flat where we intend to live, we are buying it primarily as a tool of long-term consumption, not investment.
This modification would make an inflation-targeting central bank more sensitive to at least some of the potentially dangerous developments in the financial realm. In this way, monetary policy might increase its contribution to nominal and thus also real stabilization of the economy. Widening the CPI basket would reduce the probability of at least some types of future financial crises. I hope this benefit is appreciated even by those of my friends today in this room who fear that such a broadening of the targeted price index implies that even more prices in the economy would become subject to monetary policy considerations and deliberations. After all, as Charles Kindleberger – hardly a libertarian – pointed out, financial upheavals have almost always been preceded by credit and property price booms and increasing leverage (Kindleberger and Aliber, 2011). So, there might be some space for broader agreement among economists of different schools here. And I must say we in the Czech National Bank broadly support the ideas of statistical institutions going in this direction.
I will stop here, but later during the debate I am also ready to tackle neighboring topics like deflation, macroprudential policy, or how to co-ordinate various types of policies in good times in order to avoid the over-burdening of monetary policy in bad times that we are currently observing.
References:
Akerlof, G., Blanchard, O., Romer, D., Stiglitz, J. (eds.) (2014): What Have We Learned? Macroeconomic Policy after the Crisis. The MIT Press.
BIS (2014): Monetary policy struggles to normalise. Chapter 5 in: BIS Annual Report 2013/2014. BIS.
Bordo, M. D. (2007): Gold standard. In: Henderson, D. R. (ed.) (2007): The Concise Encyclopedia of Economics, 2nd ed. Available at: http://www.econlib.org/library/Enc/GoldStandard.html
Financial Crisis Inquiry Commission (2011): The Financial Crisis Inquiry Report. Mimeo. Available at: http://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf
Fischer, S. (2015): Monetary Policy Lessons and the Way Ahead. Speech at the Economic Club of New York, New York, March 23, 2015. Available at: http://www.federalreserve.gov/newsevents/speech/fischer20150323a.htm
Hampl, M. (2011): Central Banker Seeks Revolutionary Ideas. The Wall Street Journal, February 2, 2011.
Hampl, M. (2014): BIS Bashers. Project Syndicate, September 4, 2014.
Jahan, S. (2012): Inflation Targeting: Holding the Line. Finance & Development. IMF.
Kindleberger, C., Aliber, R. Z. (2011): Manias, Panics, and Crashes: A History of Financial Crises. 6th, revised edition. Palgrave Macmillan.
Shostak, F. (2012): Contra Bernanke on the Gold Standard. Mises Daily, April 11, 2012. Available at: http://mises.org/library/contra-bernanke-gold-standard
Thoma, M. (2015): How Sticky Wages and a Flock of Ducks Can Guide Economic Policy. The Fiscal Times, April 7, 2015.