Former central banker Paul Tucker is the chair of the Systemic Risk Council, a Fellow at the Harvard Kennedy School, and author of Unelected Power: The Quest for Legitimacy in Central Banking and the Regulatory State. 

LONG BIO

How can central banks deliver credible commitment and be “emergency institutions”?

Central banks perform two apparently quite different functions. On the one hand, they are expected to operate monetary policy in a systematic manner in order to smooth fluctuations in economic activity without jeopardizing the economy’s nominal anchor. On the other hand, in their role as the lender of last resort, they are expected to operate with the flexibility of the economy’s equivalent of the U.S. cavalry.

Stanford University, Hoover Institution Conference

Paul Tucker, Harvard Kennedy School and Harvard Business School

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Central banks perform two apparently quite different functions. On the one hand, they are expected to operate monetary policy in a systematic manner in order to smooth fluctuations in economic activity without jeopardizing the economy’s nominal anchor. On the other hand, in their role as the lender of last resort, they are expected to operate with the flexibility of the economy’s equivalent of the US cavalry [note} 1 . 1 My thanks for exchanges on various of the issues covered here to Alberto Alesina, Eric Beerbohm, Steve Cecchetti, Anil Kashyap, Athanasios Orphanides, Philip Pettit, Jeremy Stein, Adrian Vermeule and Luigi Zingales. 2 system’s liquidity-insurance services being abruptly withdrawn. That, by contrast with regular monetary policy, is an institution for economic and financial emergencies. [/note]

Both those propositions invite dissent and are unquestionably contested. On monetary policy, there are those, perhaps not here in Stanford, who will want to shout that monetary policy cannot be tied to rules but must be free to meet circumstances that are hard to fathom in advance. On lender-of-last-resort (LOLR) policy, meanwhile, there are those who stress with no less vehemence that a more rule-like regime is needed in order to keep central banks from straying too far into fiscal territory: liquidity support should be distinct from a solvency bailout. Nevertheless, I suggest that the dominant views are as I initially expressed them, and not without reason. Society gives the monetary reins to unelected technocrats in order to mitigate problems of credible commitment. A necessary precondition for delivering on that promise is that policy be systematic. Big picture, this is an institution designed for normal circumstances. Having, separately, allowed fractional-reserve banking, society also wants the monetary authority to provide liquidity re-insurance to banks in order to protect it from the social costs consequent upon the private banking system’s liquidity-insurance services being abruptly withdrawn. That, by contrast with regular monetary policy, is an institution for economic and financial emergencies.

1 My thanks for exchanges on various of the issues covered here to Alberto Alesina, Eric Beerbohm, Steve Cecchetti, Anil Kashyap, Athanasios Orphanides, Philip Pettit, Jeremy Stein, Adrian Vermeule and Luigi Zingales. 2 system’s liquidity-insurance services being abruptly withdrawn. That, by contrast with regular monetary policy, is an institution for economic and financial emergencies.