The only game in town: A new constitution for money (and credit) policy

Central banks have accumulated more powers and extended the scope of their operations during and since the crisis. This poses serious questions about their independence and mandate. Tucker sets out a framework for allocating powers to an independent but accountable central bank. He addresses whether, in the so-called ‘new normal’, central banks should seek to operate directly on shorter and longer term interest rates and on the cost of private-sector credit, and discusses how macro-prudential powers affect that debate. Finally, addresses how monetary policy regimes need to adjust to what has been learned from the crisis.

Myron Scholes Lecture, Chicago Booth School of Business

Paul Tucker, Harvard Kennedy School and Harvard Business School

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Giving the first Andrew Crockett memorial lecture in June 20131 , Raghu Rajan concluded “Central banks are now the only game in town”. But Mervyn King got close to the feelings of the assembled company of central bankers when he responded, “If central bankers are the only game in town, I’m getting out of town!” (which he literally was, retiring a few weeks later).

That same weekend in Basel, the Bank for international Settlements’ annual report set out at length why and how the true heavy lifting of sustainable economic recovery was, in fact, unavoidably in the hands of the governments, banks, households and firms whose balance sheets needed strengthening. Above all, supply side reform was needed to improve future, long-term growth prospects, increasing the spending power that easy monetary policy was bringing forward. By supporting near-term demand for goods and services, the central banks could do no more than create time for those fundamental adjustments and reforms to be effected, and the BIS fretted that things would be even worse if that time was not grasped by governments and others because, perversely, they seemed less urgent. But, I would point out, fretting was all that central banks could do, short of abandoning their statutory mandate to maintain price stability and smooth, as best they could, the path of output.

Whether consciously or not, Rajan was echoing US Treasury Secretary Don Regan nearly a quarter of a century before. But with an ironic twist. Regan had been lamenting the unwillingness of US politicians to rein in the fiscal deficit, putting all the burden of establishing lower long-term nominal yields on the Volcker Fed, which was declining to monetize the growing Federal debt and, more generally, was waging a war on inflation2 . This time round, even in countries with solid public finances and even when standard monetary policy reached the zero lower bound (ZLB) for short-term nominal interest rates, politicians declined to provide sustained discretionary short-term fiscal stimulus. That left central banks having to innovate in order to generate economic recovery and, thereby, avoid deflation. Some of those innovations, notably direct interventions in credit markets, have arguably stretched the boundaries of their mandates. Coming on top of accusations that some central bank liquidity-support operations 1 Andrew Crockett was head of the Bank for International Settlements from 1994 to 2003. Amongst many other contributions to economic policy, he called in the early 2000s for a macro-prudential approach to banking system regulation. 2 William L Silber, “Volcker: The Triumph of Persistence”, 2012. Volcker was under pressure from the Reagan Administration to relax his fight against inflation in the belief th