Globalization in Central Banking

Globalization in Central Banking Pierre L. Siklos Department of Economics Wilfrid Laurier University The Power of Central Bankers Déjà Vu? Globalization in Economics: What Does it Mean? Usually associated with the growth of international trade According to economic historians, there has been a “spectacular” convergence in commodity prices since the end of the 19th century In the present context, globalization refers to: The degree to which convergence in inflation- an indicator of convergence in monetary policies - across countries has taken place The extent to which there has been a convergence internationally over the degree of autonomy and the proper goals of a central bank Convergence in Inflation: Asia-Pacific 30 20 Percent 10 0 -10 -20 20 30 Australia 60 Japan 70 80 90 00 New Zealand Convergence in Inflation: Europe 60 50 40 30 Percent 20 10 0 -10 -20 -30 1930 Austria Belgium 1960 Denmark Finland 1970 1980 1990 Ireland Italy Netherlands Norway France Germany Convergence in Europe: North America 20 15 10 Percent 5 0 -5 -10 -15 20 30 40 50 60 70 80 90 00 Canada United States What’s Old is New Again • Monetary policy would “… aim merely at lessening price fluctuations within particular business cycles, checking somewhat the upward movement and thereby lessening the subsequent decline” What’s Old is New Again • Monetary policy would “… aim merely at lessening price fluctuations within particular business cycles, checking somewhat the upward movement and thereby lessening the subsequent decline” » P. Sprague, Amer Econ. Rev, March 1921, p. 24. What’s Old is New Again • “As to the larger conclusion, we know this: Periods of serious price disturbances are periods of industrial and financial disturbance and social unrest. Practically never one without the other. And periods of price stability are periods of industrial and social equilibrium and sanity.” What’s Old is New Again • “As to the larger conclusion, we know this: Periods of serious price disturbances are periods of industrial and financial disturbance and social unrest. Practically never one without the other. And periods of price stability are periods of industrial and social equilibrium and sanity.” » Carl Snyder, Quart. J. of Econ., 1935 A Consequence of “Price Stability”? • “A business man who cannot keep infinite amounts of information in his head may worry about a few important things and ignore the rest. … Indeed, one prominent definition of “price stability” is inflation so low that it cease to be a factor in influencing decisions” » Alan Blinder, former Fed Vice-Chairman Forward Looking Monetary Policy • “Because monetary policy works with a lag, we need to be forward looking, taking actions to forestall imbalances that may not be visible for months. There is no alternative to basing actions on forecasts, at least implicitly. It means that we often have to tighten or ease before the need for action is evident to the public at large,… This process is not easy to get right…and it often difficult to convey…” » Alan Greenspan, December 5, 1996 Spoiling the Party A Stylized View of 20th Century Financial History A CENTRAL BANKING TIME LINE FOR THE 20TH CENTURY Gold Standard 1900-1924 Depression 1925-1938 WWII & reconstruction 1939-1945 Bretton Woods 1950-1973 Era of Experimentation 1974-1989 Inflation Targeting 1990-? Economic Hegemony UK & US Pegged Weakened Gold Standard Coordination Breakdown Domestic Solutions Search for a new form of Int'l coordination A new Economic Hegemony US Fixed but not Pegged Oil shocks & Divergent Policies Abandonment of BW Exch Rate Targeting Monetary Targeting Domestic search for solutions leads to common answer: Seeking Price Stability via inflation control Globalization High Globalization low Globalization High The Evolution of Central Banking in the 20th century Globalization of financial markets have risen and fallen over the decades. It may be more intensively felt today but its existence is NOT a feature of the late 20th century Nevertheless, the financial system and monetary policy decisions and outcomes were DOMINATED by the UK and the US, until WWII, and then the US alone The emergence of central banking IS a feature of 20th century financial history Prior to WWII central banks were largely PASSIVE institutions The Evolution of Central Banking in the 20th century The search for DOMESTIC solutions in the 1950-1973 period led to central banks being largely emasculated by governments and fiscal policy. Central banks were still PASSIVE institutions The 1974-1989 period led to a gradual retrenchment of government while central banks were left to search for a new anchor for monetary policy. The US was no longer driving monetary policy outcomes on a global scale A consensus emerged in the 1990s that monetary policy ought to be primarily about price stability. Moreover, price stability is best achieved via inflation targets. While the consensus was facilitated by the US (and German) experience with low inflation the current consensus stems from shared views about how best to conduct monetary policy What Globalization in Central Banking Means? Despite the differences in HOW the consensus is applied, globalization in central banking means: The retreat of the state in dictating the conduct of monetary policy [autonomy] Clarification of the mandate of central banks [accountability] Increased responsibility for delivering good monetary policy outcomes through low and stable inflation [transparency] Where there might not be consensus and dangers lurk What about unemployment and output? Can central bank policies play a role? Should these considerations be reflected in statutes? Even if the form of globalization I have been discussing takes place, are recessions inevitable? (e.g., Japan and the “hangover theory” [Krugman]) Where does autonomy end and accountability begin? The crucial role of conflict resolution. In the Beginning The Origins of Central Banks Year 1694 1800 1876 Country UK France Germany Name Bank of England Banque de France Reichsbank. Forerunner of Bundesbank 1882 1893 Japan Italy Bank of Japan Banca d’Italia Finance war Manage public debt, generate seignorage Consolidation of previous note issuing authorities following unification Part of modernization of Meiji regime Consolidation of previous note issuing authorities following unification 1913 USA Federal Reserve System Creation of lender of last resort and other banking related functions 1934 Canada Bank of Canada Lender of last resort Motivation Types of Statutory Objectives 70 60 50 40 30 20 57.0 26.0 13.0 10 3.0 0 1 1.0 Monetary stability + NO conflict Monetary stability + conflict No statutory objectives Goals other than monetary stability Only monetary stability Who Sets Targets? 30 25 Number of Central Banks 20 15 10 5 0 No Target Inflation Target Money Target Exchange rate Target No explicit target Government Both Central bank Adoption of Targets in the 1990s Exchange rate Total Adopted Total Dropped 31 Money growth 33 Inflation 50 12 7 0 The Behaviour of Inflation 14 12 Annualized Inflation rate (%) 10 8 6 4 2 0 1970 1975 1980 1985 1990 1995 Inflation targeting countries Low inflation countries Other United States Output Performance O utput Gap Forecasts (as % of Real GDP) 6 4 2 0 -2 -4 -6 -8 1965 1970 1975 1980 1985 1990 1995 Semi-Annual Forecasts Germany Japan USA 2000 The Problem of Unemployment Unemployment Rate (% of labor force) 20 15 10 Belgium Germany Italy Japan 5 0 60 65 70 75 80 85 90 95 The Behaviour of Interest Rates 24 20 16 12 8 4 0 1965 1970 1975 1980 1985 1990 1995 % per annum Belgium Germany Italy Japan Unemployment Again 14 12 10 Percent 8 6 4 2 0 60 65 70 75 80 85 90 95 United states Australia Canada Great Britain Germany Central Banks and Growth The Decade of the 1960s Index of Central Bank Independence (0-1) 0.8 The Decade of the 1980s Index of Central Bank Independence (0-1) 0.8 0.6 0.6 0.4 0.4 0.2 0.2 0.0 2 4 6 GDP growth 8 10 0.0 1 2 3 4 5 6 GDP growth Central Banks, Inflation, and Interest Rates A ve r a g e Ra te o f In fla tio n in th e 1 9 8 0 s A ve r a g e In fla tio n Ra te in th e 1 9 9 0 s 12 5 10 4 8 3 6 2 4 2 0.0 0.1 0.2 0.3 0.4 0.5 0.6 1 0.0 A ve r a g e No m in a l In te r e st Ra te s in th e 1 9 9 0 s 0.2 0.4 0.6 0.8 A ve r a g e No m in a l In te r e st Ra te s in th e 1 9 8 0 s Central Bank Independence Index C entr al Bank Indpendenc e in the 1990s 20 10 15 8 10 6 5 4 0 0.0 0.1 0.2 0.3 0.4 0.5 0.6 2 0.0 0.2 0.4 0.6 0.8 C entr al Bank Independenc e Index for the 1980s C ental bank Independenc e Index in the 1990s Accountability In d e x (0 -1 ) A New Stylized Fact? 1.0 0.8 0.6 D is c lo s u r e 0.4 0.2 0.0 0.0 In d e x (0 -1 ) 0.2 0.4 0.6 0.8 Central Bank Independence Index (0-1) 1.0 0.8 D is c lo s u r e 0.6 0.4 0.2 0.0 0.2 0.4 0.6 Accountability Index (0-1) 0.8 1.0 What’s Special about Inflation Targets? Country/ Index Targeted Australia CPI Canada CPI2 Finland CPI9 New Zealand CPI5 Separate Inflation Report? No Yes No4 Yes Who Sets Target? Government Joint Central bank Joint Publishes Inflation Forecast? No No No Yes Was Central Bank Legislation Changed? When No No Yes (after) Yes (before) Instrument Independence? (dominant) Yes (interest rate) Yes (interest rate) Limited (interest rate) Limited to Yes (interest rate) Spain CPI9 Sweden CPI UK RPI Yes Yes Yes8 Central bank Central bank Government No Yes Yes Yes (after) No Yes (after) Limited (interest rate) Limited (interest rate) Yes (interest rate) Exploding Some Myths? Central banks are not “nutters” or even near “nutters” Central bankers may not appear to care about output developments in the economy but there may be good reasons for this Problems of reliability and timeliness Can we agree on when the economy is at capacity or not? That is not to say that there are no problems with the delivery of monetary policy but the cost may be much higher volatility in inflation, output, and interest rates 35 30 NZ 8 0 s Output Variability 25 20 15 NZ 9 0 s 10 5 0 0 Can 90s US 90s Aus 80s Aus 90s Can 80s US 80s 4 8 12 16 20 24 Inflation Variability 20 Interest Rate Variability 16 NZ 8 0 s 12 Aus 90s US 80s Can 80s 8 Can 90s NZ 9 0 s Aus 80s 4 US 90s 0 0 4 8 12 16 20 24 Inflation Variability UNITED STATES 100 80 60 40 50 40 30 20 CANADA Percent 20 0 -20 -40 -60 1988 1990 1992 1994 1996 1998 Percent 10 0 -10 -20 -30 1988 1990 1992 T bill rate 1994 1996 1998 2000 T bill rate Inflation "nutter" scenario Inflation "nutter" scenario AUSTRALIA 120 160 120 80 80 40 NEW ZEALAND Percent Percent 90 91 92 93 94 95 96 97 98 99 40 0 -40 -80 -120 0 -40 -80 -160 1988 1990 1992 1994 1996 1998 Official cash rate Inflation "nutter" scenario Bank bill yield Inflation "nutter" scenario UNITED STATES 12 10 8 6 2 Actual less rate path CANADA 16 12 8 4 6 0 Actual less rate path Percent Percent 4 2 1 0 -1 -2 -3 1988 1990 1992 1994 1996 1998 4 2 0 -2 -4 1988 1990 Near "nutter" 1992 1994 T bill rate 1996 1998 Near "nutter" T bill rate Near "nutter" rate path Near "nutter" rate path AUSTRALIA 20 16 12 8 4 Actual less rate path NEW ZEALAND 20 16 12 8 8 Percent Percent 4 0 2 0 -2 -4 90 91 92 93 94 95 96 97 98 99 Actual less rate path 4 0 -4 -8 1988 1990 Near "nutter" 4 0 1992 1994 1996 1998 Near "nutter" Official cash rate Near "nutter" rate path Bank bill yield Near "nutter" rate path UNITED STATES 10 8 CANADA 16 12 Percent 6 .8 Actual less Benchmark 8 2 Actual less Benchmark 4 2 4 0 Percent .4 .0 -.4 -.8 1988 Benchmark I 1 0 -1 -2 1990 1992 1994 1996 1998 T bill rate 1988 1990 1992 1994 T bill rate 1996 1998 T bill rate path Benchmark II Benchmark I rate path Benchmark II AUSTRALIA 20 16 12 Actual less Benchmark NEW ZEALAND 20 16 12 2 1 Actula less Benchmark 8 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 90 91 92 93 94 95 96 97 98 99 4 8 4 Percent Percent 0 -1 -2 -3 1988 1990 Benchmark II 1992 1994 1996 1998 Benchmark II Official cash rate OCR path Bank bill yield Benchmark II rate path What’s Next? If globalization in central banking proceeds – together with growing economic interdependence – then does the world need as many distinct currencies as it has today? Will the “European” path become the next phase in the Globalization of central banking? POSITIVE ASPECTS: institutionalizes policy coordination, reduces transactions costs NEGATIVE ASPECTS: accountability is problematical, coordination problems acute with large numbers of countries under one monetary policy, coordination problems with fiscal policy …and a caution “Whatever its successes, the current monetary regime is far from ideal. Each episode has had to be treated as unique or nearly so. It may have been the best we could do at the moment. But we continuously examine alternatives that might better anchor policy, so that it becomes less subject to the abilities of the FOMC to analyze developments and make predictions.” Alan Greenspan