[A-List] Stiglitz: Big Lies about Central Banking

["Henry C.K. Liu" <hliu@xxxxxxxxxxxxxx>]

This was sent to me by my friend Cui Zhiyuan.
For a number of years now, the case against central banking has been my
focus.  It is good that finally, we have a Nobel economist seeing the
light, first about globalized markets and now about central banks.
Stiglitz calls for a populist appraoch.  I recall that my called for a
populist monetary policy by the Fed and was told by one self-setyled
espert on the Fed on pkt that I used words that had no meaning, even
after I pointed out that pop[ulism is a well define movement in US
politics by historians.

Stiglitz is still hedging with "There is no easy answers."  The fact is
the easy answer is there for anyone willing to find it: full employment,
whatever it takes.  But it will take an one-arm economist to see the
easy answer.

Greenspan was put in the hot seat today in Congress.  This is just the
beginning.  They will want his head on a platter before too long.

Henry C.K. Liu

Big Lies about Central Banking
                      |
|by Joseph Stiglitz
                       |
|     An independent central bank focused exclusively on price stability
has become a central part of the mantra of "economic reform." Like so
many other policy maxims, it has been repeated often enough that it has
come to be believed. But bold assertions, even from central bankers, are
no substitute for research and analysis.

|     Research suggests that if central banks focus on inflation, they
do a better job at controlling inflation. But controlling inflation is
not an end in itself: it is merely a means of achieving faster, more
stable growth, with lower unemployment.

|     These are the real variables that matter, and there is little
evidence that independent central banks focusing exclusively on price
stability do better in these crucial respects.

|     George Akerlof, who shared the Nobel Prize with me in 2001, and
his colleagues have argued forcefully that there is an optimal rate of
inflation, greater than zero. So ruthless pursuit of price stability
actually harms economic growth and well being. Recent research even
questions whether targeting price stability reduces the tradeoff between
inflation and unemployment.


|     A focus on inflation may make sense for countries with long
histories of inflation, but not for others, like Japan. America's
central bank, the Federal Reserve, is mandated not only to ensure price
stability, but also to promote growth and full employment. There is
broad consensus in the US against a narrow mandate, such as that of the
European Central Bank. Today, Europe's growth languishes, because the
ECB is constrained by its single-minded focus on inflation from
promoting economic recovery.

|     Technocrats and financial market players who benefit from this
institutional arrangemen have done an impressive job of convincing many
countries of its virtues, and of the need to treat monetary policy as a
technical matter that should be put above politics. That might be the
case if all that central bankers did was, say, choose computer software
for clearing payments.


|     But central banks make decisions that affect every aspect of
society, including rates of economic growth and unemployment. Because
there are tradeoffs, these decisions can only be made as part of a
political process.

|     Some argue that in the long run there are no tradeoffs. But, as
Keynes said, in the long run, we are all dead. Even if it were
impossible to lower unemployment below some critical level without
fuelling inflation, there is uncertainty about what that critical level
is.  Accordingly, risk is unavoidable: monetary policy that is too loose
risks inflation; if it is too tight, it can cause unnecessary
unemployment, with all the suffering that follows.

|     During America's growth boom in the 1990s, the Clinton
Administration believed that it was worth risking pushing the
unemployment rate lower, especially when the social gains--declining
welfare roles, reduced violence--were added to the direct economic
    benefits. By contrast, the IMF urged tighter monetary policy,
because it put far less weight on the cost of unemployment, seemingly no
weight on the ancillary social benefits of reducing it, and much greater
weight on the costs of potential inflation.

|     The economic analysis of Clinton's Council of Economic Advisers
turned out to be right; the models of the IMF (and the Fed) were wrong.
America secured a much lower rate of unemployment without
inflation--eventually unemployment fell to below 4%.                 |

|     But that is not the point: the point is that no one could be sure.
A calculated risk is always unavoidable. Who bears it varies with
different policies, and that is a decision that cannot--or at least
should not--be left to central bank technocrats. While there is a
legitimate debate about the degree of independence accorded to central
banks and other decision-making bodies, within a democracy, the
perspectives of those whose well-being is affected by the decisions
taken should be represented in the process.

|     Workers, for instance, who have much to lose if the central bank
pursues an excessively tight policy, do not have a seat at the table.
But financial markets--which do not have much to lose from unemployment,
but are affected by inflation--are typically well represented. And yet
financial markets hardly have a monopoly on technical competency.

|     Indeed, many in the financial community have little understanding
of the intricate workings of the macroeconomic system--as evidenced by
their frequent mistakes in managing it. For example, most US recessions
since 1945 were caused by the Fed stepping on the brakes too hard.
Similarly, central banks adopted monetarism with a fervor in the late
    1970's and early 1980's, just as empirical evidence discrediting
the underlying theories was mounting.


|     Whatever the merits of a common currency, those in Europe
deliberating about adopting the Euro should consider whether to tie
their fortunes to an institutional arrangement whose flaws are
increasingly apparent. Likewise, developing countries need to consider
not only the central bank's independence, but also its mandate and
representativeness. They need to balance concerns about economic
efficiency with those of democratic accountability.

|     In many new democracies, citizens are bewildered. The virtues of
the new regime are first praised, but then they are told that the
macroeconomic policy decisions about which they care most are too
important to be left to democratic processes. Citizens are warned
    against the risks of populism (meaning the will of the people?).


|     There are no easy answers. But in too many countries, nor is there
democratic debate about the alternatives.

|     Joseph E. Stiglitz is Professor of economics and finance at
Columbia University and was the 2001 Nobel laureate in Economics.
Previously, he was Chairman of President Clinton's Council of Economic
Advisers, and Chief Economist and Senior Vice President of the World
Bank. His book "Globalization and Its Discontents" was published in
Russian this spring.
|
|     Copyright: Project Syndicate, June 2003.