The Boundaries of Central Banks

Transcription

1 The Boundaries of Central Banks Ignazio Angeloni (**) XX International Tor Vergata Conference on Money, Banking and Finance 7 December 2011 (**) Tentative thoughts for discussion All views are personal and attributable only to the author 1

2 What is happening to central banking? The financial crisis has unsettled its foundations: CBs seem to pursue new objectives (financial stability, market repair) They seem unconcerned about the traditional ones (price stability) Has the established paradigm become irrelevant? If so, why? What will come next? Hard times ahead for central banks: Adverse economic conditions Lack of accepted theoretical guide, trial and error policy Independence under threat A fundamental rethinking has started Good news for research! But remember Keynes: to make progress we need to escape from old ideas, always a painful process 2

3 Outline 1. Foundations of the old paradigm 2. Lessons from history 3. The boundaries of central banks o Why boundaries? o Dimensional boundaries o Functional boundaries o Operational boundaries o Geographical boundaries 4. The ECB approach vs. the others 5. Redefining the boundaries: tentative conclusions and open questions 3

4 Three pillars of the old paradigm Single focus Exclusive focus on price stability (variation of a CPI index at short horizon) However: monetary policy affects also financial stability (a risk taking channel of monetary transmission) Independence Neither seek nor accept influence by politics or private interests However: independence is increasingly challenged, as central bank responsibilities broaden Assignment principle Neither should central banks be distracted by other goals (lest losing credibility), nor should other authorities be concerned about price stability However: if monetary policy can contribute to financial stability, and financial policies affect price stability, it is hard to eschew multiple goals 4

5 Some current questions Is the exclusive or overriding focus on CPI inflation misplaced? Should CBs have multiple mandates? Should they be last resort lenders for sovereigns? Have CBs taken on too much risk, and are they still credible/trustable? Should CBs be concerned about systemic risk? Should they look across borders be concerned about global developments? (just to name a few) 5

6 Lessons from history (before Great Moderation) Watersheds in CB doctrine are recurrent. Goodhart 2010: 1. The Victorian period ( ) Gold standard, free capital flows, fixed exchange rates Priority to external balance Central bank dominance 2. The fiscal dominance period ( ) Dollar standard, capital controls, fixed exchange rates Priority to external balance (except US) Central bank subordination 3. The triumph of markets period ( ) No anchor, free capital flows, floating exchange rates Priority to internal balance Central bank dominance again 4. (What next?) 6

7 About central bank boundaries An interpretation: CB bounds have broadened Narrow central bank: Uses a small number of instruments, Conducts small size trades, With a small number of trading partners, Pursuing a single goal within a single country Broad central bank: Uses many more instruments, Conducts large size trades, With many trading partners, Pursuing multiple goals in an international (or global) context 7

8 Four dimensions of broadening Dimensional boundaries: The balance sheets of all major CBs have expanded widely CBs take on part of the bank intermediation function Challenges: taxpayer risk, lower efficiency Functional boundaries: CBs pursue multiple goals at a time Challenges: credibility, consistency, communication Operational boundaries: The trading modalities of the CB multiply Advantage: permits multiple goals (to some extent) Challenge: role of market retreats Geographical boundaries: Concern for systemic risk, international transmission Challenge: policy coordination is difficult and controversial 8

9 Dimensional boundaries (1) L Central bank A CB money Refinancing L Banks A Deposits Refinancing CB money (B) Loans/securities A Private and public sector L CB money (P) Deposits Loans/securities 9

10 Dimensional boundaries (1) Large size L Central bank A Small size [Deposits at CB] CB money Refinancing [Repoed loans/securities] L Banks A Deposits Refinancing CB money (B) Loans/securities A Private and public sector L CB money (P) Deposits Loans/securities 10

11 Dimensional boundaries (2) Eurosystem Federal Reserve Bank of England Bank of Japan Pre crisis Present Pre crisis Present Pre crisis Present Pre crisis Present Total assets 13% 26% 6% 19% 6% 18% 19% 30% Sovereign bonds outright 0% 2% 6% 11% 0% 14% 11% 13% Monetary base 9% 14% 6% 18% 5% 13% 17% 24% Money (M1) 43% 51% 10% 14% 62% 72% 94% 109% Eurosystem: SMP; Fed: US Treasury securities held outright; BoE: gilts purchased under the Asset Purchase Facility; BoJ: Japan Gov. Bonds and Treasury Discount Bills purchased outright

12 Dimensional boundaries (2) Total assets Eurosystem Federal Reserve Bank of England Jul 07 Oct 07 Jan 08 Apr 08 Jul 08 Oct 08 Jan 09 Apr 09 Jul 09 Oct 09 Jan 10 Apr 10 Jul 10 Oct 10 Jan 11 Apr 11 Jul 11 Oct 11 Jan 07 Apr 07 Index (Jan2007=100)

13 Dimensional boundaries (2) Eurosystem E U R b illio n 2,000 1,800 1,600 1,400 1,200 1, Jan 07 Apr 07 Jul 07 Oct 07 Jan 08 Apr 08 Net foreign assets Covered Bond Purcha s e Progra mme Main refina ncing operations USD repo and swaps Jul 08 Oct 08 Jan 09 Apr 09 Jul 09 Oct 09 Jan 10 Apr 10 Jul 10 Oct 10 Jan 11 Apr 11 Jul 11 Domestic assets Longer term refinancing operations Marginal lending facility + Fine tuning operations Securities Markets Progra mme Oct 11

14 Dimensional boundaries (2) Federal Reserve U S $ b illion Jul 07 Oct 07 Jan 08 Apr 08 Jul 08 Oct 08 Jan 09 Apr 09 Jul 09 Oct 09 Jan 10 Apr 10 Jul 10 Oct 10 Jan 11 Apr 11 Jul 11 Oct 11 U.S. Treasury securities Regular repos Other lending (Standing and Special Facilities) Fed TAF (excl. other central banks) Central bank USD swaps Total assets Federal agency debt (Fannie, Freddie) MBS Net Foreign Assets Lending to specific institutions (Bear S.,AIG,CPFF) Domestic assets (held outright)

15 Functional boundaries (1) Three basic functions 1. Interest rate setting 2. Liquidity management 3. Financial stability (monitoring, regulation, supervision) and what they require: 1. A mandate, a goal, a model of monetary transmission, a decision making committee 2. Ability to create accepted legal means of payments 3. Financial sector information (micro and macro systemic), legal power, a decision making body WHICH IS THE MOST INHERENT TO CENTRAL BANKS? 15

16 Functional boundaries (1) Three basic functions 1. Interest rate setting 2. Liquidity management 3. Financial stability (monitoring, regulation, supervision) and what they require: 1. A mandate, a goal, a model of monetary transmission, a decision making committee 2. Ability to create accepted legal means of payments 3. Financial sector information (micro and macro systemic), legal power, a decision making body THIS ONE IS 16

17 Functional boundaries (2) Implementation of IRS decisions They coincide when the ZLB is reached LM Lender of last resort, moral hazard, information requirements IRS Risk-taking channels Macro-prudential effects of monetary policy FS 17

18 Functional boundaries (3) Some tips from those who know: T. Padoa Schioppa (2003): The role of central banks in financial stability is part of their genetic code; an integral part of their monopoly on ultimate liquidity C. Goodhart (2010): [IRS] is not essential to a central bank it could easily be done by a study group. One could envisage a separate body, whose sole function would be to determine the official interest rate, but I rather doubt this would be the most sensible approach. On balance: Separating the functions appears impractical, creates more problems than it solves However: Combining them creates formidable challenges for central bank strategy and communication

19 Operational boundaries (1) ECB PRE CRISIS: Main Refinancing Operations (variable rate tenders) Longer term Refinancing Operations (LTRO) with 3 month maturity Fine tuning Operations Minimum Reserves Standing Facilities => interest rate corridor ECB POST CRISIS: Fixed rate and full allotment in MROs and LTROs LTROs with maturities up to 1 year Enlarged list of collateral, suspension of ratings Narrowing of interest rate corridor FX operations Covered Bond Purchase Programmes (CBPP) Securities Markets Programme, sterilised with one week CB deposits

20 Operational boundaries (2) The ECB separation practice: liquidity management in support of market functioning can be conducted to some extent independently from official interest rate setting (instead, in normal conditions LM simply supports IRS) Trichet (2008): The ECB makes a clear separation between, on the one hand, the determination of the monetary policy stance and, on the other hand, its implementation using liquidity operations Goodhart (2010): under conditions of financial disturbance and crisis, liquidity management takes a life on its own, potentially independent of official interest rates This is only possible when markets are dysfunctional and for short periods of time

21 Operational boundaries (3) What is liquidity? NARROW: Short term assets of the banking sector with the central bank, typically composed of banknotes stored in the bank s vaults and free reserves deposited with the central bank. (ECON 1 TEXTBOOK) BROAD: Property of financial markets; markets are said to be liquid when assets can be sold ( liquidated ) with minimal or no change in price and loss of value. (MICRO FINANCE LITERATURE)

22 Geographical boundaries Intellectual dominance of inflation targeting with floating exchange rates during the Great Moderation A stable system without either gold, the dollar or the IMF (A. Rose JIMF 2007) Limitations as global monetary template Self regulating nature of floating questionable In real world, fear of floating remains widespread Neglects concern for financial stability Neglects spillovers through capital flows, asset prices, commodity prices Caruana (2010): The externalities arising from monetary policy spillovers need to be internalised; in an interconnected world it may not be enough to keep one s own house in order However: monetary policy coordination is difficult and controversial 22

23 Conclusions and open questions Experience shows that central bank boundaries are flexible: they expand in times of crisis, when markets retreat This is rooted in the central banks unique role as ultimate providers of trust (solvency) Are markets subject to systematic euphoria and depression? Ask the behavioural sciences Can moving CB boundaries be consistent with a (properly defined) price stability mandate? How does monetary policy work in distressed markets? Central bank paradigm is changing; how long will this take? What compass shall we use in the transition? To work! Economists are more useful now than 5 years ago Remember Keynes warning! 23

24 Readings I found useful Ahamed (2007) The Lords of Finance Borio (2011) Central Banking post Crisis Bruner, Carr (2009) The Panic of 1907 Caruana (2011) The Role of Central Banks after the Crisis Eichengreen et al. (2010) Rethinking Central Banking Giannini (2011) The Age of Central Banks Goodhart (2010) The Changing Role of Central banks Kindleberger (1978) Manias, Panics and Crashes Padoa Schioppa (2003) Central Banks and Financial Stability; Exploring a Land in Between Trichet (2008) Some Lessons from the Financial Market Correction 24