Duncan’s Economic Blog

Monetary Policy: A Question to Readers.

Posted in Uncategorized by duncanseconomicblog on June 16, 2009

Is it just me or is monetary policy really interesting right now? 

We have a stark divide between deflation concerns and inflation fears. A debate on whether or not the green shoots are real or entirely due to technical factors such as inventory re-stocking. And we have Central Banks engaging in policy that would have been unthinkable just a year ago. 

What’s more we have genuine conflict. 

In Britain last year there was a very public debate between Danny Blanchflower and the Governor. The ECB is riddled with divisions. In Sweden a similar fight is developing. Merkel has attacked pretty much every central bank in the West.

This can all seem a bit academic to most people – but it’s vitally important. The decisions of Mervyn King, Ben Bernanke and Jean-Claude Trichet over the next few months will ultimately probably matter more than those of Alistair Darling, Tim Geithner and Peer Steinbruck. Remove the massive monetary stimulus too quickly and the world could fall into a deflationary spiral, leave it in place too long and we might see a rapid increase in inflation.

There is an unwritten convention that politicians don’t comment on monetary policy and now leave it to independent central banks. Consensus now is that monetary policy should be run by non-elected technocrats aiming at a government set target. Merkel has broken the convention. As an open question to my readers: how much should politicians talk about monetary policy?

6 Responses

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  1. Tom Freeman said, on June 16, 2009 at 10:49 am

    Good question.

    In theory, politicians should feel free to talk about any area of public policy; in practice, assuming that we support central bank independence, they should be careful. If politicians express too strong a view about the conduct of monetary policy, the rate-setters may find themselves worrying about their reappointment if they take a different view. Indeed, the markets may start to worry that political pressure will have an effect.

    Conversely (and I think this seemed to happen a bit in the early years of the ECB), the central bank may hold off making justifiable rate cuts just to demonstrate its independence in the face of political calls for cuts.

    Maybe Michael Howard’s old distinction between operational and policy-making matters can help here: within a given rationale for conducting policy (e.g. a 2% CPI target), politicians should be very reluctant to express views on the merits of particular interest-rate decisions. But when there are grounds for doubting the existing rationale, this has to be a political decision and should be discussed as such.

    And the use of unconventional techniques such as QE, when the Treasury has some involvement, is also a legitimate object of political debate – although the actual use of that technique should be left as far as possible to the Bank.

    Finally, I feel more comfortable with, say, a Select Committee making political scrutiny and commentary of policy conduct than with frontbenchers doing the same. In the former case there’s much less of a connection between the commentary and the ability to pull strings.

  2. chris said, on June 16, 2009 at 12:24 pm

    The interesting thing about Merkel’s line is that it contradicts the conventional economic argument for politicians to keep out of monetary policy.
    This argument was/(is?) that politicians have an incentive to over-inflate the economy in the short-term for electoral reasons, causing inflation to be higher over the long-term; the time-inconsistency problem.
    However, Merkel’s point is the exact opposite. Here we have a politician wanting a tougher anti-inflationary policy than the independent central banks are offering.
    Which raises the question: was/is the orthodox argument for independent central banks ever right, or did it rest upon a straw man of the politician who wants inflation?

  3. CharlioemcMenamin said, on June 16, 2009 at 12:25 pm

    I’ll ask a counter question which I think is somewhat broader.

    Why can’t everything affecting public policy be decided by elected representatives, ideally subject to popular recall? The standard answer usually points to some highly specialised areas – science, medicine that sort of thing – and says that professional expertise is necessary to ensure that correct decisions are made rather than ill-informed, populist ones. (Certainly I wouldn’t want questions like MMR vaccination or epidemic control decided by politicians alone). So the politicians’ role becomes to design institutional arrangements which protects this professional independence whilst allowing an appropriate ‘window’ for popular concerns, whether expressed via elected representatives or directly, to also input into the debate. (BTW, I think the distinction between policy making and operations lies underneath this primary distinction: even if you believed, say, the Minster for Health, not NICE should decide on which drugs to provide on the NHS you’d still not want a popular vote on which patients should be prescribed which drugs when…)

    Now, let’s think about central bank independence in this light. It too is designed to provide a firewall to prevent ‘populist’ decisions being made. In particular it is designed to make sure that inflationary pressures do not build up due to the potential populist demands for additional public spending, re-distribution or higher wages. But it is not at all clear to me that such demands must be resisted on an ‘expert-knows-best’ basis. They are being guarded against, surely, because some people, in the international money markets (& no doubt elsewhere), like things the way they are with our currently hugely skewed distribution of incomes and wealth.

    I’m sorry to come across as incredibly old fashioned and out of tune with the times, not to mention a economic ignoramus – but, really, what arguments are there that central bank independence isn’t simply a huge con designed to insulate class power from popular pressure?

  4. Andreas Paterson said, on June 16, 2009 at 8:57 pm

    I’d have to say that personally I’m not all that keen on central bank independence, I think that ultimately interest rates are a political decision and should be made by politicians. I think this could be done without entirely sidelining the experts, you could retain the MPC and have the make a monthly recommendation but leave the ultimate decision to the Chancellor. If the recommendation was published alongside the decision it would mean that there was still a degree of political pressure to constrain excessive populism.

    I also agree with Charlie’s point, I think that at the moment the system seems stacked in favour of financial interests. I personally think we’re a little too paranoid about inflation at the moment. Ultra low inflation (by which I mean our current 2%) would seem to quite clearly have positive benefits for financiers, but I don’t think the case for it’s overall benefit to the economy has ever really been made.

  5. Mr. Mxyzptlk said, on June 16, 2009 at 9:02 pm

    You can vote out politicians but not Central bankers don’t seem right to me…I wont mention democratic

  6. econometrician said, on December 5, 2009 at 4:36 pm

    Now it needs to change. http://econometrician.wordpress.com/


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