Central bankers: smarter or better informed?

Secretary-General of the OECD

Inflation has been brought under control in OECD and non-OECD countries alike, including in Latin America and Africa. This progress is thanks in no small part to strong action by central bankers.

I have always admired the unique role of central bankers. As we reflect from time to time upon reincarnation as a possible next step, I lean towards that option. The governor of an independent central bank has my vote.

Over the past seven years, I have visited the central banks of nearly every OECD country. There are strong commonalities. Usually there prevails an atmosphere bordering on that of a temple, combining a sense of deep reflection and contemplation. There is no sense of frenetic activity as one finds in government departments, or here at the OECD. At central banks, people actually study, think, reflect and even conclude from time to time on the direction of monetary policy. It is this last step which attracts everyone’s attention. Only at that point do the critics descend!

Since my involvement in public policy as a member of the Trudeau cabinet in Canada in the early 1980s, monetary policy has focused public attention on price stability rather than money supply, but the latter remains important. There has also been widespread recognition of the importance of the independence of central banks, or reserve banks as some are called.

Controlling inflation through monetary policy has been quite remarkable over the last 20 years. Are there evident reasons for this success?

I am a fan of Alan Greenspan, as a person and a central banker. He was eulogised and sometimes vilified in his role. Well, who would you rather have at the control panel of the Federal Reserve than Alan Greenspan? Was he to identify the high tech stock market bubble and tell us all to bail out? Ask the question and you have the answer. He hinted that we should reflect on “irrational exuberance”, and that was as far as he went, and in my view, appropriately so. (Unfortunately, many did not listen).

Some of his predecessors were also very capable, and it is equally true of other countries who have nominated and supported very competent central bankers.

Why has price stability become the public focus of central banks as opposed to money supply in its various definitions? And why have central bankers been so successful in achieving such stability, which they were unable to do in the past?

They have not ignored money supply, but the declared focus is on price stability. Inflation is the worst of all economic evils: it attacks anyone and everyone not indexed by the state or employers against its consequences, and of course, those who pay the indexation suffer as well. Witness the soaring public deficits of the early 1980s, where many entitlement programmes were indexed and tax revenues often were not. Ultimately, it attacks employment, and economic and social well-being. Everyone is seriously affected. One cannot manage a balanced market economy within the volatility of rampant inflation. Nothing is predictable!

Alan Greenspan, chairing the OECD Economic Policy Committee in 1976 ©OECD/Sabine Weiss

Now it is true that countries with chronic inflation have managed to survive. But can one think of any significant successful economy that has lived with high inflation?

Recently, central bankers were right to make price stability the target, and the record shows that they have been very good in meeting that objective. Why have they been more successful than their predecessors? There may be a cocktail of reasons, but one must surely be information. They know more about what is happening in the economy thanks to better data delivered with unprecedented speed through our new world of information and communication technology. Levels of stocks, investment intentions, consumer confidence, etc: they have more real time data than their predecessors could have dreamt of. And for the most part they have used it well.

But was it only effective monetary policy that led to the great moderation in inflation in the OECD economies and beyond? Look at these numbers from a recent comment by Kenneth Rogoff of the IMF:

“The story in advanced countries is well known and much has been written: inflation averaged 9% in the first half of the 1980s, versus 2% since the beginning of this decade. But the performance of the developing countries is even more remarkable, with inflation falling from a 1980-84 average of 31% to an average of under 6% for 2000-03. For 1990-94, inflation in Latin America averaged over 230%, the Transition Economies over 360% and Africa 40%. For 2003, all three regions are projected to have inflation around 10%.”

Some of the reasons for this lowering of inflation include: the independence of central bankers who refused to stimulate economies at the whim of political masters; more liberal markets and deregulation which allowed competitive forces to make prices react accordingly; globalisation which brought even more competition to domestic markets; a smaller public sector in most countries with less union power in public sector wage settlements which had at times set the lead for the private sector; and a public which finally recognised the inherent sickness and social and economic instability of galloping inflation.

Take your pick, as no doubt each of these has had a role to play. But monetary policy was critical, no matter what scenario you choose. So be grateful to independent central bankers. And be jealous, removed as they are from the “hurly burly” of partisan politics and other parochial issues that beset the rest of us on a daily basis.

©OECD Observer November 2003 




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