What numbers should central bankers like Mark Carney, Mario Draghi and Jerome Powell go to bed thinking about? Inflation? The rate of unemployment? GDP growth? Productivity? In other words, what should the target of an independent central bank be? After several years of lying dormant, this old question has, if not quite exploded in a volcanic eruption of debate, at least begun to rumble again.
Labour broached the issue last week with its publication of a report for the party by GFC Economics which suggests the Bank of England’s mandate ought to be modified to include a target of 3 per cent annual productivity growth. This follows a paper earlier this month from Lawrence Summers (the veteran US economist who came close to being appointed by Barack Obama as the chair of the US Federal Reserve a few years ago) suggesting the Fed ought to move to a “nominal GDP” target.
Although droves of politicians in the UK, the US and across the EU have moaned and even raged about the decisions of central banks in recent years – including Theresa May – virtually none have called for decisions on interest rates to be put back into the hands of politicians. Indeed, scarcely any have even called for the mandate of those banks to be changed. Like Stanley Baldwin’s 1920s press barons, they seem to prefer the power of the bully pulpit without the tedious responsibility of actually having to do any thinking about the sensitive trade-offs inherent in their simplistic demands.
So, in this depressing context, this flicker of fresh thinking about central bank mandates is welcome.
Such a debate can help to clarify that central banks, despite the impression given by the populist agitators, are not a law unto themselves. Policymakers do not arbitrarily decide what is good for the public and what is to be avoided, who should be subsidised and who should be penalised, who should be made richer and who should be made poorer.
The banks are operationally independent only – they work to achieve broad goals set for them by elected governments. That’s true of the Bank of England, the Federal Reserve, the European Central Bank and indeed all of the independent monetary authorities across the Western world, from Sweden, to Canada, to New Zealand.
But what should the democratically selected target of those institutions be? They have all traditionally been given (roughly) the same target of 2 per cent annual inflation, and told to aim to hit it over the medium term. However, there is no macroeconomic reason why 2 per cent inflation, as opposed to, say, 4 per cent, should be the magic number consistent with full employment, steady GDP growth and macroeconomic stability.
And indeed the Summers argument is that this old framework, which seemed to work reasonably well before the global financial crash, is now breaking down. In an era when both interest rates and inflation are apparently being chained down by powerful secular economic forces, monetary policy is left potentially impotent to restore growth in the event of a downturn. Summers wants a nominal GDP target (inflation and real growth added together) of 6 per cent.
For similar reasons, Simon Wren-Lewis of Oxford University prefers a primary target of maximising GDP growth, with an inflation target transformed into a backstop. Others have previously suggested simply raising the inflation target from 2 per cent to 4 per cent.
The objection of Bank of England policymakers and officials to GDP targets is that growth data from statistics agencies, unlike inflation data, is often revised over time, sometimes dramatically, and that setting this metric as the target could result in wild and damaging policy swings.
Advocates see this as an exaggerated technical quibble. It also fails to engage with the central objective of the reform, which is to shift the mindset of central banks so that policymakers and staff will no longer consider miserable productivity and weak GDP growth acceptable merely because inflation has been quiescent.
The usual response of institutional conservatives to the idea of raising the inflation target to 4 per cent is that it would shatter the central bank’s credibility and befuddle the public although, in truth, there’s not much real evidence to believe this. Reasonable people can differ about the relative strength of these mandate proposals and the various objections. Yet all sensible people should welcome the rumbling of a radical debate here.
It’s true that it’s unhealthy to expect central banks to solve all of a society’s economic problems. These institutions cannot please all the people all the time. Yet it is healthy to talk seriously and constructively about what it is we want our central banks to do.