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WHAT IS CENTRAL ABOUT CENTRAL BANKING?: 

A STUDY OF INTERNATIONAL MODELS 

HEARING 

BEFORE THE

SUBCOMMITTEE ON MONETARY 

POLICY AND TRADE 

OF THE

COMMITTEE ON FINANCIAL SERVICES 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED THIRTEENTH CONGRESS 

FIRST SESSION 

NOVEMBER 13, 2013 

Printed for the use of the Committee on Financial Services 

Serial No. 113–50 

( 

(II) 

HOUSE COMMITTEE ON FINANCIAL SERVICES 

JEB HENSARLING, Texas, Chairman 

GARY G. MILLER, California, Vice Chairman 

SPENCER BACHUS, Alabama, Chairman 

Emeritus 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

SHELLEY MOORE CAPITO, West Virginia 

SCOTT GARRETT, New Jersey 

RANDY NEUGEBAUER, Texas 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

MICHELE BACHMANN, Minnesota 

KEVIN McCARTHY, California 

STEVAN PEARCE, New Mexico 

BILL POSEY, Florida 

MICHAEL G. FITZPATRICK, Pennsylvania 

LYNN A. WESTMORELAND, Georgia 

BLAINE LUETKEMEYER, Missouri 

BILL HUIZENGA, Michigan 

SEAN P. DUFFY, Wisconsin 

ROBERT HURT, Virginia 

MICHAEL G. GRIMM, New York 

STEVE STIVERS, Ohio 

STEPHEN LEE FINCHER, Tennessee 

MARLIN A. STUTZMAN, Indiana 

MICK MULVANEY, South Carolina 

RANDY HULTGREN, Illinois 

DENNIS A. ROSS, Florida 

ROBERT PITTENGER, North Carolina 

ANN WAGNER, Missouri 

ANDY BARR, Kentucky 

TOM COTTON, Arkansas 

KEITH J. ROTHFUS, Pennsylvania 

MAXINE WATERS, California, Ranking 

Member 

CAROLYN B. MALONEY, New York 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

STEPHEN F. LYNCH, Massachusetts 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

GWEN MOORE, Wisconsin 

KEITH ELLISON, Minnesota 

ED PERLMUTTER, Colorado 

JAMES A. HIMES, Connecticut 

GARY C. PETERS, Michigan 

JOHN C. CARNEY, JR., Delaware 

TERRI A. SEWELL, Alabama 

BILL FOSTER, Illinois 

DANIEL T. KILDEE, Michigan 

PATRICK MURPHY, Florida 

JOHN K. DELANEY, Maryland 

KYRSTEN SINEMA, Arizona 

JOYCE BEATTY, Ohio 

DENNY HECK, Washington 

SHANNON MCGAHN, Staff Director 

JAMES H. CLINGER, Chief Counsel 

(III) 

SUBCOMMITTEE ON MONETARY POLICY AND TRADE

JOHN CAMPBELL, California, Chairman 

BILL HUIZENGA, Michigan, Vice Chairman 

FRANK D. LUCAS, Oklahoma 

STEVAN PEARCE, New Mexico 

BILL POSEY, Florida 

MICHAEL G. GRIMM, New York 

STEPHEN LEE FINCHER, Tennessee 

MARLIN A. STUTZMAN, Indiana 

MICK MULVANEY, South Carolina 

ROBERT PITTENGER, North Carolina 

TOM COTTON, Arkansas 

WM. LACY CLAY, Missouri, Ranking 

Member 

GWEN MOORE, Wisconsin 

GARY C. PETERS, Michigan 

ED PERLMUTTER, Colorado 

BILL FOSTER, Illinois 

JOHN C. CARNEY, JR., Delaware 

TERRI A. SEWELL, Alabama 

DANIEL T. KILDEE, Michigan 

PATRICK MURPHY, Florida 

(V) 

C O N T E N T S 

Page 

Hearing held on: 

November 13, 2013 ........................................................................................... 1 

Appendix: 

November 13, 2013 ........................................................................................... 35 

WITNESSES 

WEDNESDAY, NOVEMBER 13, 2013 

Lachman, Desmond, Resident Fellow, American Enterprise Institute ............... 5 

Makin, John H., Resident Scholar, American Enterprise Institute .................... 8 

Orphanides, Athanasios, Professor, Practice of Global Economics and Management, Sloan School of Management, Massachusetts Institute of Technology . 7 

Posen, Adam S., President, Peterson Institute for International Economics ..... 10 

APPENDIX 

Prepared statements: 

Lachman, Desmond .......................................................................................... 36 

Makin, John H. ................................................................................................. 49 

Orphanides, Athanasios ................................................................................... 62 

Posen, Adam S. ................................................................................................. 68 

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Huizenga, Hon. Bill: 

Wall Street Journal article entitled, ‘‘ECB’s Praet: All Options on Table,’’ 

dated November 13, 2013 ............................................................................. 79 

Written statement of Lawrence Lindsey ........................................................ 82 

Wall Street Journal article entitled, ‘‘Andrew Huszar: Confessions of a 

Quantitative Easer,’’ dated November 11, 2103 ......................................... 98 

(1) 

WHAT IS CENTRAL ABOUT CENTRAL 

BANKING?: A STUDY OF 

INTERNATIONAL MODELS 

Wednesday, November 13, 2013 

U.S. HOUSE OF REPRESENTATIVES, 

SUBCOMMITTEE ON MONETARY

POLICY AND TRADE, 

COMMITTEE ON FINANCIAL SERVICES, 

Washington, D.C. 

The subcommittee met, pursuant to notice, at 2:27 p.m., in room 

2128, Rayburn House Office Building, Hon. Bill Huizenga [vice 

chairman of the subcommittee] presiding. 

Members present: Representatives Huizenga, Pearce, Posey, 

Fincher, Stutzman, Mulvaney, Pittenger, Cotton; Clay, Perlmutter, 

Carney, and Kildee. 

Ex officio present: Representative Hensarling. 

Mr. HUIZENGA [presiding]. The subcommittee will come to order. 

And without objection, the Chair is authorized to declare a recess 

of the subcommittee at any time. It appears that we will be having 

votes somewhere around 4:15 or 4:30, is the indication that we 

have. 

So with that, we are going to get moving, because we have a lot 

of very interesting stuff ahead of us as a committee today. And the 

Chair is going to recognize himself for 5 minutes for the purpose 

of an opening statement. 

So we have to ask ourselves, what is central about central banking? What works? What doesn’t? What thinking went into forming 

the European Central Bank 80 years after the formation of our 

own Federal Reserve and how has it lived up to expectations so 

far? Did it perform better or worse among its peer institutions in 

the wake of the financial crisis? 

It is these questions and others that our committee is interested 

in exploring as we consider potential reforms of our own Federal 

Reserve System, which is posting its 100th anniversary this year. 

This afternoon, we welcome our witnesses: Dr. Desmond 

Lachman from the American Enterprise Institute; Dr. Athanasios 

Orphanides from the Massachusetts Institute of Technology; Dr. 

John Makin from the American Enterprise Institute as well; and 

Dr. Adam Posen from the Peterson Institute for International Economics. 

Gentlemen, thank you very much for being here today. We appreciate your time. 

2 

Today’s hearing will examine the central banks of the other advanced economies around the world, focusing on their governance 

and policy tools, as well as their successes and failures in implementing monetary policy. 

The Federal Reserve prides itself on being an independent central bank here in the United States. However, independence is 

hard to measure and even more difficult to demonstrate. The appointment process of policymakers, reporting requirements, and 

policy review processes all play a role in defining the relationship 

that central banks have with their own national governments. 

Even still, the most independent central banks are ones where 

there is very little coordination or interference by fiscal policy decisions. 

In 2009, the Bank of International Settlements (BIS) surveyed 41 

central banks and reported on both the broad commonalities in the 

structures and roles of these institutions as well as the differences 

among them. The BIS reported that all the central banks it surveyed have full or partial responsibility for monetary policy. Over 

half are given policy objectives, usually specified in domestic law or 

international treaty, but some policy objectives come by published 

statements that do not have the force of law. Many have either a 

‘‘single mandate’’ of pricing stability or a primary goal of price stability with secondary macroeconomic objectives. The United States 

and Canada are the only two countries identified as having a price 

stability mandate equally weighted with other macroeconomic objectives. I think this dual mandate is what we will be discussing 

quite a bit. Nearly all central banks have full responsibility for formulating and implementing monetary policy. 

Specifically, we will explore today international models of central 

banking. Some central bank models, like our own U.S. Federal Reserve System, have a ‘‘dual mandate’’ of enacting monetary policy 

with a goal of maximizing employment while simultaneously minimizing inflation. Other countries’ central banks work under a more 

focused or prioritized mandate or set of mandates. And that is 

what I am hoping to personally hear today from all of you. 

Some, like myself, also believe that the employment component 

at a minimum has diverted the Fed’s attention from the more important issue of inflation, which in my opinion should be the sole 

focus. In the worst case, an equal price stability and employment 

mandate has the potential of a moral hazard, with the Fed playing 

off its regulatory role against its monetary role. 

I look forward to hearing from our witnesses today as we compare and contrast with other international banking models. What 

we will learn today should not only inform our own understanding 

of the increasingly global and complex macroeconomy, but should 

also contribute to our efforts to enact reforms on our own Federal 

Reserve System as it hits its 100th anniversary milestone. 

And with that, the Chair is going to yield back the rest of his 

time. 

The Chair now recognizes the distinguished ranking member of 

the subcommittee, Mr. Clay of Missouri, for 5 minutes. 

Mr. CLAY. Thank you, Mr. Chairman, and thank you for holding 

this hearing regarding central banks of other advanced economies 

and focusing on their governance. 

3 

In the United States, the Full Employment and Balanced Growth 

Act of 1978, better known as the Humphrey-Hawkins Act, set four 

benchmarks for the economy: full employment; growth in production; price stability; and balance of trade and budget. Also, Humphrey-Hawkins charges the Federal Reserve with a dual mandate: 

maintaining stable prices; and full employment. 

The Bank of International Settlements report found that many 

nations have either a single mandate of price stability or a primary 

goal of price stability with a secondary macroeconomic objective 

like full employment. The United States and Canada are the countries identified as having a price stability mandate equally weighted with other macroeconomic objectives. Many central banks have 

sole inflation targets, sole exchange rate targets, and others have 

price stability targets. Also, asset portfolios of central banks vary 

considerably. Some hold foreign assets, government debt, and 

claims on financial institutions. And during the financial crisis, the 

Federal Reserve purchased commercial paper, made loans, and provided dollar funding through liquidity swaps with foreign central 

banks. 

Due to this action, the Federal Reserve Bank balance sheet has 

expanded. When you look at the European Central Banks (ECBs), 

their main objective for the euro system is price stability and safeguarding the value of the euro. During the financial crisis and the 

euro crisis, the ECB used several policy tools, including long-term 

liquidity, refinancing liquidity swaps with the Federal Reserve, and 

purchase of the euro denominating covered bonds and other government bonds on the secondary market. The ECB’s balance sheet 

has expanded. 

The Bank of Japan set monetary policy to achieve price stability. 

During the financial crisis, the Bank of Japan purchased private 

debt security, offered long-term refinancing operation, and provided 

dollar funding through liquidity swaps with the Federal Reserve. 

The Bank of Japan’s balance sheet has expanded. 

And one more example. The Swiss National Bank’s primary goal 

is to ensure price stability. During the financial crisis, its balance 

sheet has expanded. 

Mr. Chairman, I will conclude there with my opening statement. 

And I look forward to the witnesses’ comments. I don’t know if the 

gentleman from Colorado wants me to yield—I yield the rest of my 

time to the gentleman from Colorado. 

Mr. PERLMUTTER. I thank the gentleman. 

Just a couple of points. Listening to the Chair’s opening, I personally think that you can’t operate in a vacuum, that you have to 

compare your price stability inflation versus how many people are 

working and what the economy is doing. And we have enjoyed a 

very low inflation rate now for a number of years, even with pretty 

expansionary monetary policy. But we have had very checkered fiscal policy in the process. 

And so, I do appreciate the gentlemen for testifying today. I look 

forward to your testimony. But I, for one, support sort of the Humphrey-Hawkins approach, which is you don’t look at just any one 

thing. And I know certain central banks, that is their sole focus. 

I appreciate the fact that the Federal Reserve in our country gets 

4 

to look at more than just one thing and has the responsibility to 

address more than just one thing. 

With that, I yield back. 

Mr. HUIZENGA. The gentleman yields back. 

With that, the Chair would like to recognize Mr. Stutzman from 

Indiana for 3 minutes for an opening statement. 

Mr. STUTZMAN. Thank you, Mr. Chairman. 

And I want to thank each of you for being here, and also thank 

the chairman and the ranking member for holding this hearing to 

evaluate various central bank structures throughout the world, 

many of which look very different than our own U.S. Federal Reserve System. 

I want to thank each of you for being here and for bringing your 

expertise in order to examine the ways we might analyze these different central banking systems. Conducting an honest evaluation 

here will allow us to better understand how well our own systems 

function. 

I remain particularly interested in those governments without a 

dual mandate, which is most of the world. As you may know, Mr. 

Chairman, I have authored a bill, the FFOCUS Act, which eliminates the Fed’s dual mandate in order to focus on price stability. 

I have said before that the American people can ill afford the inflation, debt, and insecurity that this misguided approach threatens. 

Now is the time to repeal the dual mandate and break this destructive cycle and return to a predictable, rules-based system. 

Numerous economists and scholars have come before our committee supporting this position and reiterating that the dual mandate undermines any attempt to fashion predictable monetary policy. I agree with those who say the dual mandate underpins the 

Fed’s rationale for greater discretion when forming monetary policy, creating a troubling lack of accountability and oversight. 

Today, I look forward to examining other global models and how 

they seek to strike the right balance of independence and oversight. 

Lastly, I remain troubled at the Fed’s bloated balance sheet and 

I remain unconvinced that there is a viable exit strategy from the 

Fed’s policy of quantitative easing. So in this light, I am in interested in how other central banks handle the makeup of their balance sheets and what lessons we can take away from them. 

Again, thank you for holding this hearing, and I look forward to 

the testimony of our witnesses. And I yield back, Mr. Chairman. 

Mr. HUIZENGA. The gentleman yields back. 

And with that, I would like to extend a warm welcome to our 

panel of distinguished witnesses today. We are going to be starting 

from our left to right here with Dr. Desmond Lachman. He is a 

resident fellow at the American Enterprise Institute. He has previously taught at Georgetown and Johns Hopkins Universities. He 

served as a deputy director of policy development review at the 

International Monetary Fund and has worked as a managing director and chief emerging market economic strategist at Solomon 

Smith Barney. 

We also have Dr. Athanasios Orphanides, a professor of the practice for global economics and management at MIT Sloan School of 

Management. He served a 5-year term on the European Central 

Bank Governing Council as a governor of the Central Bank of CyVerDate Nov 24 2008 16:55 Apr 17, 2014 Jkt 086685 PO 00000 Frm 00010 Fmt 6633 Sfmt 6633 K:\DOCS\86685.TXT TERRI
5 

prus. He also served as a senior adviser to the Federal Reserve 

Board of Governors and taught courses at Georgetown and Johns 

Hopkins Universities as well. 

Dr. John Makin is a resident scholar at the American Enterprise 

Institute. Previously, he worked as the chief economist at Caxton 

Associates. He has served in capacities at the Bank of Japan, the 

U.S. Treasury Department, the International Monetary Fund, and 

the Federal Reserve Banks of both San Francisco and Chicago. He 

has also taught courses at the University of Wisconsin, Milwaukee, 

the University of Virginia, and the University of British Columbia. 

Finally, last but not least, Dr. Adam Posen is president of the 

Peterson Institute for International Economics. Previously, he has 

served as a member of the Bank of England’s Monetary Policy 

Committee and also worked as an economist at the U.S. Treasury 

Department. 

Gentleman, you will be recognized for 5 minutes each to give 

your oral presentation of your testimony. And, without objection, 

your written statements will also be made a part of the record. 

On your table right in front of you, you see lights. It will start 

out green. When it turns yellow, you have 1 minute to sum up. And 

when it turns red, you will be hearing my gavel shortly after that. 

So we would like you to wrap that up and pay attention to that 

timing. And once each of you has finished presenting, each member 

of the committee will have up to 5 minutes within which to ask any 

or all of you questions. 

And with that, Dr. Lachman, you are recognized now for 5 minutes. And welcome. 

STATEMENT OF DESMOND LACHMAN, RESIDENT FELLOW, 

AMERICAN ENTERPRISE INSTITUTE 

Mr. LACHMAN. Thank you, Mr. Chairman, Ranking Member 

Clay, and members of the subcommittee for affording me the honor 

of testifying before you today. I am going to talk about the four 

major central banks of the world: the United States; Japan; Europe; and the Bank of England. 

Over the past 5 years, all of those banks have pursued unorthodox monetary policies on an unprecedented scale. This has led 

to massive expansion in these central banks’ balance sheets and it 

has taken monetary policy into entirely uncharted waters. 

Since September 2008, with the Lehman crisis, the motivation 

for the pursuit of unorthodox monetary policies in all of the major 

industrialized economies has broadly been similar. All of these 

countries’ central banks needed to intervene aggressively in financial markets to repair the damage wrought by the Lehman crisis. 

In addition, with policy interest rates having reached their zero 

lower bound, and with unusually weak economic recoveries and 

very low inflation, these central banks have all felt obliged to resort to policies aimed at reducing long-term interest rates, increasing asset prices, and encouraging risk-taking. 

While unorthodox monetary policies have led to a dramatic expansion in all four major central banks’ balance sheets to a range 

of between 20 and 30 percent of the respective countries’ GDPs, 

there has been a marked difference in the manner in which these 

central banks have implemented their policies. Underlying these 

6 

differences have been basic differences in the structure of these 

countries’ financial systems, as well as in the specific problems that 

these individual central banks have been trying to address. 

Assessing the relative success of unorthodox monetary policy pursued by the major industrialized countries is rendered difficult and 

subject to debate for two basic reasons. The first is that we cannot 

know what the counterfactual would have been had these policies 

not been pursued. The second is that it is still far too early to know 

what the longer run consequences of these policies will be since we 

do not yet know what will happen once these policies are unwound. 

Having said that, there would seem to be little room for debate 

about the success of these policies in restoring the proper functioning of the global financial system in the immediate aftermath 

of the Lehman crisis. There also seems to be little room for doubt 

that the world’s major central banks have succeeded in lowering 

long-term interest rates and in boosting asset prices. 

In addition, it would seem that the ECB’s Outright Monetary 

Transaction program, announced in August 2012, was highly successful in substantially reducing sovereign borrowing costs in Europe’s troubled economic periphery, while the Bank of Japan’s more 

aggressive round of quantitative easing, announced in 2012, has 

succeeded in substantially weakening the Japanese yen, thereby increasing Japanese inflationary expectations. 

Now, critics of qualitative easing observe that despite the large 

decline in long-term borrowing rates and the strong increasing 

local asset prices, the economic recovery in industrialized countries 

is the weakest of the post-war period. While true, this criticism 

would not seem to be a serious indictment of recent quantitative 

easing policies. It overlooks the fact that absent forceful central 

bank action, it is highly probable that the industrialized countries 

would have again leapt into serious recession. 

A more serious line of criticism of the unorthodox monetary policies being pursued by the world’s major central banks is that too 

little regard is being paid to the unintended longer run consequences flowing from these policies. These consequences could 

materially compromise the longer run global economic outlook. 

Among these unintended consequences are, first, the risk that 

these policies might be giving rise to excessive risk-taking and to 

bubbles in asset and credit markets. In this context, one has to 

wonder whether historically low yields on junk bonds in industrialized countries now understate the risk of owning those bonds and 

whether yields on sovereign bonds in European periphery have not 

become disassociated from those countries’ economic fundamentals. 

The second unintended consequence is that there have been large 

spillovers to other economies through capital flows and exchange 

rate movements that have given rise to the charge of currency war. 

This is of particular concern to the dynamic emerging markets’ 

economies, whose growth prospects have been compromised. 

The third drawback of these policies is the moral hazard to 

which they give rise by reducing the urgency of governments to undertake necessary but painful economic reforms. This would seem 

to be particularly apparent in both Europe and Japan. 

Since the Lehman crisis, the U.S. economy has performed relatively well in relation to those of the eurozone, Japan, and the 

7 

United Kingdom. Nevertheless, it would seem at least two lessons 

for the Federal Reserve can be drawn from the experience of the 

central banks in those countries. First, Europe’s particularly poor 

economic performance in the aftermath of the Lehman crisis would 

suggest that a single inflation objective mandate and a high degree 

of central bank independence do not guarantee meaningful economic recovery. 

Second— 

Mr. HUIZENGA. I’m sorry, Dr. Lachman, but your time has expired. So I will let you wrap up with one quick sentence, and then 

we are going to have to move on. We can explore that further in 

questions. 

Mr. LACHMAN. All right. The final point I would make is that 

aside from the experience of other central banks, I think that the 

United States’ own experience would also caution it against the 

danger of running up very large assets and credit market bubbles, 

and that in the conduct of this policy, one really has to be mindful 

not simply of the short run effects of policy, but also of the longer 

run costs that we might yet find that we are going to pay. 

Mr. HUIZENGA. Thank you. With that, the gentleman’s time has 

expired. 

[The prepared statement of Dr. Lachman can be found on page 

36 of the appendix.] 

Mr. HUIZENGA. Dr. Orphanides, you are recognized for 5 minutes. 

STATEMENT OF ATHANASIOS ORPHANIDES, PROFESSOR, 

PRACTICE OF GLOBAL ECONOMICS AND MANAGEMENT, 

SLOAN SCHOOL OF MANAGEMENT, MASSACHUSETTS INSTITUTE OF TECHNOLOGY 

Mr. ORPHANIDES. Thank you, Mr. Chairman. I appreciate the opportunity to testify at this hearing. As requested, my testimony will 

focus on differences and similarities between the Fed and the ECB. 

I think the 100-year anniversary of the Fed is an apt occasion for 

reflecting on the structure of the institution. Historical experience 

suggests that a well-functioning monetary system is a prerequisite 

for the greatness of any nation, and this is what has been achieved 

since the creation of the Federal Reserve 100 years ago. 

Since its founding, the Fed has evolved into a very powerful central bank and serves a leading role in global central banking. As 

a public institution, the Federal Reserve is unparalleled in the professional integrity, technical expertise, dedication to public service, 

and collegiality that has characterized its staff and leadership. 

Over its first 100 years, the Fed has contributed, I believe, to the 

welfare of the Nation, but has not always managed to avoid major 

errors. The Great Depression of the 1930s and the great inflation 

of the 1970s are the most noticeable examples. I am certain that 

historians will reflect on the most recent crisis over the next many 

years. In my view, the Fed’s actions in late 2008 and 2009 were 

decisive for averting what could have become an economic collapse 

of Great Depression dimensions. 

However, the easy money policies that have been pursued do create additional challenges. And right now we do see that the central 

bank’s balance sheet and associated continued easing are unprecedented. 

8 

What I would like to draw attention to is three elements between 

the Fed and euro system. One is in the decentralized nature of the 

institutions. This is a common characteristic that is quite important in that the inclusiveness and incorporation of regional perspectives ensures that monetary policy better reflects the needs of 

a broad economy, which we have in both cases. 

The second element is the independence of both institutions. 

Both the Federal Reserve and the ECB are very independent central banks, but the ECB is more independent than the Federal Reserve in that its operations are governed by treaty and not by law, 

and as a result it cannot be changed very easily by modifying a 

piece of legislation. 

There is another difference that has to do with the appointment 

process of Board Members. Both in the United States and in Europe, once appointed, the Board Members are independent; however, the reappointment process and turnover in the United States 

arguably makes that aspect of independence less in the United 

States relative to Europe. 

I believe that the independence of the Federal Reserve could be 

strengthened, and that would be an improvement, if its Board 

Members were appointed similarly to the ECB Executive Board 

Members for just one nonrenewable 8-year term. 

The third element I would like to draw attention to is the difference in the mandates of the two institutions where, as has been 

pointed out already in the introductory remarks, the Federal Reserve is governed by a dual mandate that emphasizes, in addition 

to price stability, full employment. Whereas, in the case of the 

ECB, price stability is the primary focus of the institution. There 

I believe that the ECB’s mandate better reflects the accumulated 

knowledge we have had in central banking experience over the 

20th Century. It is generally accepted that better results, both in 

terms of economic stability and in terms of price stability, can be 

delivered by a central bank that can focus its attention better and 

be held accountable for what it can do, and that is price stability. 

So in this sense, I would share concerns that have been expressed, for instance, recently by Chairman Volcker, who pointed 

out that if the Federal Reserve is trying to pursue multiple objectives, it runs the risk of losing sight of its basic responsibility for 

price stability that would end up delivering worse results in all of 

its objectives together. I believe that these risks could be mitigated 

by Congress with a clarification that explicitly recognizes the primacy of price stability as an operational goal for the FOMC. And 

I believe that subject to that objective, the Fed would be in a better 

position to attain additional objectives such as full employment for 

the Nation. 

Thank you. 

[The prepared statement of Dr. Orphanides can be found on page 

62 of the appendix.] 

Mr. HUIZENGA. Thank you, Dr. Orphanides. 

With that, we have Dr. John Makin for 5 minutes. 

STATEMENT OF JOHN H. MAKIN, RESIDENT SCHOLAR, 

AMERICAN ENTERPRISE INSTITUTE 

Mr. MAKIN. Thank you, Mr. Chairman. 

9 

I want to briefly review the experience of the Fed and the experience of other central banks since the financial crisis. Given that 

time is somewhat limited, I have tried to lay out some of the approaches that central banks have taken to the crisis. I would remind the committee that the Fed was originally formed after a series of financial crises, the last of which was the crisis of 1907, 

which underscored the need for some kind of an institution to provide adequate liquidity in order to avoid the negative effects of financial crises, such as those that followed from the numerous crises that occurred in the 30 to 40 years before the Fed was formed. 

The Lehman crisis was unique. I bring to it the perspective both 

of an academic and a think tanker, but also someone who was in 

the middle of the crisis, working at a hedge fund at the time. And 

I can assure you that the role of the central bank as an institution 

designed to avoid a total financial meltdown was one of the primary activities that emerged. The typical goals of the Fed, that is 

price stability and full employment, were subsumed beneath or 

among the more primary objective of the Fed to try to staunch the 

severe bleeding that had emerged in the financial sector. 

In order to follow up and try to restore the growth of employment 

and to maintain stable prices, the Fed extemporized, using the zero 

interest rate policy, the quantitative easing, forward guidance. All 

of these measures were pioneered by the Fed in response to the crisis that was facing them. Other central banks to some degree followed the example of the Fed. You may remember that initially the 

European Central Bank felt that they had avoided the financial crisis and its fallout. And that outlook was changed in 2009 when it 

was revealed that the Greek Government was concealing the 

amount of fiscal deficits that it was undertaking. 

So basically, central banks have tended to stylize their responses 

to the crisis, again, as measures designed to try to avoid financial 

meltdowns. The Bank of Japan this year, as most of you know, initiated measures that were quite similar to what the Fed had undertaken, that is they set a goal for 2 percent inflation and they 

undertook aggressive additions to their balance sheet in order to 

try to effect that goal. 

The outcomes have varied, and I have tried to actually summarize them in my testimony in terms of evaluating what central 

bank has performed best. In the first figure, I look at the path of 

gross domestic product from 2008 to the present, and the winner 

is the United States. Although growth has been slow to somewhat 

lagging—it is on page 7 of the testimony—the United States has 

seen a total increase, cumulative increase in output of about 8 percent since 2008. The biggest loser is Spain in this picture because 

Spain is part of a monetary union in which it does not belong; that 

is the ECB sets monetary policy for Germany, the rest of Europe 

has to struggle, and the result is a rapid drop in output. 

Inflation has not been a big problem so far. In fact, disinflation 

is emerging as a big problem in Europe and the United States. Figure 2 looks at price levels. The cumulative increase in the price 

level in the United States, in spite of heavy quantitative easing 

since 2008, is something on the order of, again, 8 percent. In Switzerland and Japan, prices have actually fallen. And one of their big 

10 

problems has been to intervene heavily to avoid currency appreciation intensifying their deflation problem. 

The second wing of the mandate, that is employment, is looked 

at in terms of figure 3. Central banks have not been terribly successful at engendering growth of employment. And here again, in 

terms of what the committee is considering, I, too, share the idea 

that it is probably best to have the central bank target a stable 

price level. And by that, I mean that inflation should not be above 

2 percent, but it should not be below 1 percent. And in an environment where you can get deflation, it is important to put a floor on 

that range. But in general, the behavior of employment suggests 

that the central banks have not been terribly successful in pursuing that goal. 

I see my time is up, so I will stop. 

[The prepared statement of Dr. Makin can be found on page 49 

of the appendix.] 

Mr. HUIZENGA. Thank you, Dr. Makin. 

Dr. Posen, you are also recognized for 5 minutes. 

STATEMENT OF ADAM S. POSEN, PRESIDENT, PETERSON 

INSTITUTE FOR INTERNATIONAL ECONOMICS 

Mr. POSEN. Thank you, Mr. Chairman. Since my colleagues, 

Athanasios, Desmond, and especially John, have taken you through 

the basics comparisons, I am going to make slightly more pointed 

remarks. I am going to talk about the operational structure of central banks and what the Fed is doing right and wrong in two major 

areas, The first issue is of governance and how its goals are set, 

which goes to the mandate issues and Humphrey-Hawkins issues 

that people have raised, and the second is about the tools that are 

available for policy implementation. 

I would argue that the differences between central banks are 

going to actually become more important in the next couple of 

years. In the midst of a crisis, whatever a country’s mandate, whatever a central bank’s mandate, everybody is going in the same direction, pretty much. And if they don’t go in the same direction, 

they realize very quickly that they have to catch up, and you throw 

everything you have at the problem. 

And if you look back, particularly at John, but also at the other 

testimony, you will see that the central banks did largely the same 

thing. All this talk about the difference in mandate and uncertainty caused by the Fed’s dual mandate is absolute nonsense. 

There is no evidence econometrically that it makes a difference either to the perceived uncertainty in financial markets or to the levels of inflation you see. 

So what does matter? Let’s talk a bit about goals. The central 

banks, as Stanley Fischer has pointed out, should not have goal 

independence, but should have instrument independence. In other 

words, all of you here as the elected officials should be setting what 

the central bank’s goals are, debating them, resetting them as necessary, but then leaving the central bank alone to get on with the 

job and not worry too much about how they get on with it, only 

checking for competence and results after the fact. 

Perhaps this sounds evident, but this distinction matters greatly. 

Athanasios mentioned that the ECB has an extreme form of indeVerDate Nov 24 2008 16:55 Apr 17, 2014 Jkt 086685 PO 00000 Frm 00016 Fmt 6633 Sfmt 6633 K:\DOCS\86685.TXT TERRI
11 

pendence and insulation from political oversight. Back in 1993, I 

predicted that this would be the case and would lead to excessively 

rule-based behavior. And that is exactly what we saw with the 

ECB running the European economy partway into the ground. 

We know that in the Bank of England, and then more recently 

in the Bank of Japan, we have seen resetting of the policy goals 

by elected officials in an explicit, transparent manner, taking advantage of the crisis and saying, what have we learned? And this 

has suffered no shock to inflation, nor stability; it is the way it 

should work. 

So does the Fed have it right? I think largely we can say yes. 

But I think there are three points I would make. First, an atmosphere of extreme distrust from Congress towards the Fed is harmful and unnecessary. We have the whole notion of auditing the Fed, 

which is looking as though the Fed isn’t totally transparent about 

its balance sheet, which it is. We have the idea of minutes having 

to be very explicit and tell you everything that was said exactly, 

which has the effect of making people ashamed to really debate in 

the FOMC because they are worried about being caught up. We 

have the fact that capital in the central bank is not guaranteed and 

therefore the Fed restricts itself from engaging in policies it should, 

such as potentially selling off assets, because they don’t want to 

have to come to you and explain an on-paper loss. You could indemnify the Fed against losses incurred in the operation of its duties, as Her Majesty’s Treasury does for the Bank of England. 

Most importantly and harmfully, Congress has put increasing restrictions on what the Fed can purchase. This is a terrible step 

backwards in policy. Every central bank in the world except the 

Fed can purchase a broader range of assets than the Fed currently 

does. Every central bank in the world for centuries has purchased 

private assets and a wide range of assets. It was only this brief 

interlude from the late 1970s to the early 2000s when central 

banks made the mistake of thinking they could affect the whole 

economy by playing at the short end of the yield curve in the government bond market. That has been demonstrated to be completely wrong by the experience of the last few years. Look at the 

fact that in Europe right now, you have a total crushing of small 

business credit in southern Europe because the ECB chooses only 

to purchase certain things at the international level. 

Let’s talk for 1 minute left on tools. Building on this point about 

where the central bank—Congress has fruitlessly and destructively 

restricted the Fed’s purchases. We have the fact that we get this 

demonization of purchases and large balance sheets and so-called 

unconventional monetary policy. Now, the fact is, unless you buy 

the right things, your policies will be ineffective. The Bank of 

Japan proved this with its quantitative easing in the mid-2000s 

when it only bought short duration debt and had no effect on the 

economy. Once they shifted to buying private and longer term debt, 

they have managed to reverse deflation. 

It is wrong in the United States to think that there has been any 

mistake here. If the United States hadn’t been lucky in the fact 

that Congress has allowed the Fed to buy guaranteed mortgagebacked securities, we would not have had an effective policy response. Had we not had that effective policy response, we would 

12 

not have the housing-led recovery, such as it is that we have today. 

And that was sheer luck that Congress happened to have approved 

of MBS purchases. 

To repeat, no other major central bank is constrained the way 

Congress has constrained the Fed in its purchases. This is taking 

the Fed in exactly the wrong direction. 

Thank you, Mr. Chairman. 

[The prepared statement of Dr. Posen can be found on page 68 

of the appendix.] 

Mr. HUIZENGA. I appreciate that input. 

And I need to make sure that I get my notes here for a moment. 

Because of the shutdown that had occurred, we had a well-known 

expert on the subject who we invited to the original scheduled October hearing, but he is unable to attend today. And without objection, I would like to put Dr. Larry Lindsey’s prepared testimony 

into the record. So without objection, we will do so. 

And with that, the Chair is going to recognize himself for 5 minutes. 

Mr. Posen, you are on a bit of a roll against Congress here, and 

I would add that you are not unique in that in many ways lately. 

Mr. POSEN. My complaints are more narrow, sir. 

Mr. HUIZENGA. Yes, yes. I understand your complaints are more 

narrow. Come to a town hall meeting sometime, and you will have 

your world broadened. 

But I just wanted to make sure that you had a chance to express 

that fully about the limits on the purchases and those kinds of 

things. And then I would like the rest of the panel to maybe touch 

on that and whether they would agree with that. 

Mr. POSEN. Very kind of you, Mr. Chairman. And again, obviously, I am working in shorthand; there is no one entity of Congress, and there are obviously people like you and this committee 

who want to thoughtfully try to do the best possible job. And that 

is why I am grateful that we are having this hearing. 

Mr. HUIZENGA. Duly noted, the buttering up. I appreciate it, 

though. So I thank you. 

Mr. POSEN. Transparency. The issue is pretty straightforward in 

my eyes. Central banks literally did most of their operations on private loans and private securities throughout the 19th Century and 

throughout much of the 20th Century. They did so in an environment with many different things going on, but rarely resulting in 

inflation, rarely resulting in hyperinflation, rarely resulting in instability. And they did this because it had two advantages. First, 

it directly went after issues in the markets where there were 

blockages in the markets. And second, this helped to make markets 

and create more liquid conditions more broadly that you could intervene. 

Now, there are costs to doing this because it does of course benefit specific holders of given assets at a given time, which you don’t 

want to do. And there are costs because if it is a narrow market 

you happen to buy into, it is not that easy to get in and out and 

the Fed can have too large, or whatever central bank, can have too 

large an effect on the asset prices. So it is not costless, but it is 

a tool. 

13 

Mr. HUIZENGA. Would anybody else on the panel care to comment on that quickly? Dr. Lachman? 

Mr. LACHMAN. I would just make the point that the size of the 

asset purchases by central banks is without any precedent. It is on 

a scale that is humongous. So I think not to have congressional 

oversight on the particular assets that are being made when you 

are getting distributional effects, I am not sure that I would go 

along fully with Mr. Posen’s point. 

Mr. HUIZENGA. Okay. And I would like to just quickly, I am 

going to take a moment. I would like to submit this into the record, 

without objection. 

This is from yesterday’s Wall Street Journal, ‘‘Confessions of a 

Quantitative Easer.’’ This was Andrew Huszar, who is a senior fellow at Rutgers Business School, and a former Morgan Stanley 

managing director. In 2009 and 2010, he managed the Federal Reserve’s $1.25 trillion agency mortgage-backed securities purchase 

program. And I don’t know if anybody else has read this. If so, I 

would love to get a comment on it. But basically, a little headline: 

‘‘We went on a bond-buying spree that was supposed to help Main 

Street. Instead, it was a feast for Wall Street.’’ 

Dr. Makin? 

Mr. MAKIN. The ‘‘feast for Wall Street’’ rhetoric is popular, but 

I think it obscures a problem that the Fed faces. And that is, on 

the one hand, they want to make sure that they keep the recovery 

going. And so, they are buying assets. I agree that they should be 

able to buy a wider range of assets. But given the constraints they 

are facing, they have to buy the assets in order to keep the recovery going. On the other hand, they are supposed to avoid affecting 

asset prices, which of course is impossible. 

And the dilemma they face was highlighted last May when Fed 

Chairman Bernanke suggested that perhaps they should taper or 

they should reduce the rate at which they are purchasing securities. The result was a 1.5 percentage point increase in mortgage 

borrowing rates. So I think perhaps the author of the Journal 

piece, it is easy to criticize, but, on the other hand, if you withdraw 

what the Fed is doing, you risk some serious problems in the financial markets. And so in summary, what the central bank, especially 

the Fed is trying to do is to find a way out of providing a large 

amount of support for financial markets without disrupting the behavior of the economy and causing a sharp rise in interest rates. 

It is very difficult to do. 

Mr. HUIZENGA. Dr. Orphanides, for the last 30 seconds. 

Mr. ORPHANIDES. Thank you, Mr. Chairman. I would also agree 

that it is an unfair criticism both for the Federal Reserve and for 

other major central banks to claim that they have been trying to 

help the banking system and not Main Street. In order to best help 

Main Street, central bank policies often have to focus on the financial sector. This is what we have seen both in this country and in 

other countries. 

With regard to the purchases of securities, I would agree with 

Dr. Posen that it would be useful for the Federal Reserve to have 

the authority to make purchases of other instruments. This is exceptionally important in times of crisis when even very small interventions by the central bank could unclog markets. 

14 

In the case of Europe, this proved very important. For example, 

in 2008, 2009, the ECB made small purchases in the covered bond 

markets just for a short while, and that helped stabilize the market 

and restore stability. So you don’t need many purchases, you need 

it as a crisis management tool. That said— 

Mr. HUIZENGA. I’m sorry. Unfortunately, my time has expired. So 

we are going to have to allow one of my colleagues to explore that. 

The last thing I would like to do, without objection, is also put 

into the record an article entitled, ‘‘ECB’s Praet: All Options on 

Table, Central Bank Could Adopt Negative Deposit Rate, Asset 

Purchases If Needed.’’ So without objection, it is so ordered. 

With that, I would like to recognize Mr. Clay for 5 minutes. 

Mr. CLAY. Thank you, Mr. Chairman. 

Today, it is widely acknowledged that over the past few decades 

the United States experienced a sharp rise in income inequality, 

levels of inequality not seen since the late 1920s. Moreover, a recent study out of Berkeley has shown that most of the benefits of 

growth experienced during the recent recovery have accrued to the 

wealthiest in society. 

And when you talk about Fed policies having important distributional impacts on society, do you believe these policies in any way 

contribute to the problem of growing inequality? Can you give us 

some examples of Fed decisions that have impacted different segments of society differently and how? I want to start with Dr. 

Posen. 

Mr. POSEN. Thank you, Mr. Clay. 

The ongoing rise in income inequality, and particularly wealth 

inequality in the United States, is largely driven by the U.S. Tax 

Code, which you are well familiar with, obviously. It is secondarily 

driven by a global trend that low-skilled Americans and low-skilled 

workers are getting less and less ability to bargain for wages, while 

people at the high end of the scale in terms of perceived skill or 

opportunity get to bargain at superstar status. Those are the two 

main drivers, and those continued through the crisis. 

The crisis made things worse in the United States and elsewhere 

because of course the most vulnerable become unemployed and you 

see fiscal cutbacks on the provisions that go out to them. Particularly in the United States we saw at the State and local government level, that it was a big cutback and cutback opportunities 

through the community college and other such systems. Again, this 

committee is well familiar with that. 

Where does the Fed come into this? The Fed basically is contributing to inequality. But similar to what Athanasios, Dr. 

Orphanides just said, it is contributing to inequality in a minor 

way to prevent a very concentrated blow to inequality in a major 

way. 

Let me spell that out. The way the Fed policy is working is it 

is benefiting stockholders and relatively middle-income householders, people with mortgages, disproportionately. And then you 

hope that by benefiting those, that will lead to growth in the rest 

of the economy. And that isn’t going for equality. 

Had the Fed not taken the course it did, you would have seen 

a much higher increase in small business failures and in unemployment. And so the overall inequality picture might not have been 

15 

that different, but the concentration of very bad outcomes would 

have been very high. 

Mr. CLAY. I see. 

Dr. Makin? 

Mr. MAKIN. I agree that the tax system is a much more effective 

way to address problems of inequality than the Fed. The Fed’s 

goals are already perhaps more than instruments they have to 

achieve them with, that is to maintain inflation at a low and stable 

level and to try to minimize unemployment. To that extent, they 

are trying to deal with all sectors of the economy. But for the Fed 

to be charged in any specific way, I don’t know what instrument 

the Fed would use to affect income distribution. So I would turn 

to the Tax Code to effect that outcome, and suggest that perhaps 

a flatter schedule of tax rates would be a good idea. 

Mr. CLAY. Thank you. 

Dr. Orphanides, would you have any comment on the income inequality? 

Mr. ORPHANIDES. Thank you. I would like to emphasize that central banks do not have the tools to achieve all that society might 

wish that government institutions might be able to contribute to. 

The best way central banks can contribute to even an element such 

as the reduction of inequality is by ensuring stability in the economy, the preconditions for economic growth that can then allow 

households and corporations and businesses to prosper and allow 

the Congress with fiscal policy to select distributional policies it 

would have with high income. 

We cannot expect central banks to deal with this problem. I believe that in the last few years, we have been overburdening central banks already. We expect them to keep interest rates low and 

help fiscal policy as well. We expect them to contribute much more 

than they can to full employment. We expect them to fix all the 

problems of the financial system. We cannot have all of these expectations simultaneously. 

Mr. CLAY. Dr. Lachman? 

Mr. LACHMAN. Yes, I would basically agree— 

Mr. HUIZENGA. The Chair is going to take a prerogative here. My 

time went a little long, so without objection, I will grant just this 

answer. 

Mr. CLAY. Thank you. 

Mr. LACHMAN. I will keep it really brief. I would certainly agree 

that you don’t want to overburden the central bank with too many 

things to do, that price stability is a big enough task that will do 

a lot of good. So I would think that other policies, fiscal policies, 

stuff of that sort, is a more appropriate way to deal with the distribution issue. 

Mr. CLAY. Thank you, Mr. Chairman. 

Mr. HUIZENGA. No problem. Thank you. 

With that, the Chair is going to recognize Mr. Pearce of New 

Mexico for 5 minutes. 

Mr. PEARCE. Thank you, Mr. Chairman. 

Mr. Makin, you had made a comment there in response to the 

gentleman from St. Louis’ question about income inequality. Would 

you state that again? I am just not sure that I heard the whole 

thing. 

16 

Mr. MAKIN. Very briefly, as the other panel members have suggested, the central bank is really not equipped to address issues of 

income distribution. And the tax system is a better way to do that. 

Mr. PEARCE. And would you have any ideas, understanding it is 

not the Federal Reserve or central bank’s job, but what would you 

recommend on the tax policy if you were going to make a recommendation? 

Mr. MAKIN. I would prefer a kind of textbook approach, which 

was followed in the 1986 tax reform, which was to have the lowest 

possible rate on the broadest possible base. So that would partly 

involve financing lower marginal tax rates by closing loopholes, 

among other things. 

Mr. PEARCE. Mr. Posen, the Federal Reserve has driven interest 

rates to almost zero—or to actually zero. Is that a good policy long 

term for the United States? 

Mr. POSEN. Congressman, it was a good policy and it remains a 

good policy given the economic context in which we find ourselves, 

and it is a policy that has very little in the way of long-term implications. Despite the comments made by Dr. Lachman earlier, there 

is no statistically significant evidence across countries that low interest rates lead to bubbles. It is just not there in the data. It requires a combination of regulatory changes and animal spirits to 

get bubbles. Low interest rates don’t cause them. And if it is not 

about bubbles, it is not clear what it does. 

There are second order, meaning existing but not huge distributional effects. My mother, who is a retiree, who has mostly invested 

all her savings in government bonds has less income now because 

the Fed did that. Other retirees who happen to have 401(k)s have 

more income because the stock market went up. The Fed can’t fine 

tune that without getting into deep trouble. And I think on net, it 

is not a big deal one way or the other. The interest rate only— 

Mr. PEARCE. If I could take back my time right there, I would 

invite you to come to my town halls. 

Mr. POSEN. Okay. 

Mr. PEARCE. I have seniors, we have a little bit older population 

in New Mexico, they come there for the hot, dry weather. They say, 

we lived our life correctly, we paid for our houses, we have cash 

equivalents. We used to get 4 percent income—this statement was 

made this past week—on our investments, and now we are getting 

one quarter of 1 percent. So for every $16 they used to live on, now 

they have $1. And they are spending into their capital. 

And to hear you describe that as not significant, I would like you 

to use that terminology in front of the hostile people that I get to 

face at our town halls. Because I will guarantee you, my friend, it 

is a significant impact on the lives of seniors who have lived correctly, and because of the policies of this government and this Administration, they cannot even live in retirement. And to have that 

described as nonsignificant statistically just drives people insane 

when they hear folks in Washington say crap like that. Statistically 

not important. 

Do you have a response? 

Mr. POSEN. Yes, indeed. 

Mr. PEARCE. Yes? 

17 

Mr. POSEN. I have two responses. First, when I was serving at 

the Bank of England I did those town halls myself, without the 

protection of some local Congressman or MP. I talked to over 8,000 

individual U.K. citizens while I was there. And I held myself accountable to people. And I explained to them that just as you think 

about the 4 percent you used to have wasn’t controlled by you and 

wasn’t set by the government, it was a market effect. In reality, if 

this economy is not growing, there is no interest rate out there. 

And it is not for the Federal Reserve to subsidize people just because they happened to have done what you call living correctly. 

Secondly— 

Mr. PEARCE. I have 24 seconds, sir. And the Federal Reserve is 

subsidizing Wall Street, because zero interest rates are a boon to 

the big bankers. They get money for free, and they are able to then 

charge more. 

Mr. Chairman, I yield back my time. Thank you. 

Mr. HUIZENGA. The gentleman yields back his 5 seconds. All 

right. 

With that, the Chair recognizes— 

Mr. PERLMUTTER. The gentleman from Colorado. Ed Perlmutter, 

the gentleman from Colorado. 

Mr. HUIZENGA. Yes, my former neighbor who moved away from 

me. 

Mr. PERLMUTTER. How soon you forget. 

Mr. HUIZENGA. Yes. With that, the gentleman has 5 minutes. 

Mr. PERLMUTTER. Mr. Posen, I have a bunch of questions. Do you 

want to finish your second point to Congressman Pearce? 

Mr. POSEN. That is very generous. I will be brief. The definition 

of living correctly is in the eye of the beholder. Most human beings 

in the United States live correctly. And whether it is the children 

of the unemployed; they don’t deserve to bear the burden of the crisis any more than the people you are meeting with in your town 

halls. I wouldn’t make a moral judgment. 

Mr. PERLMUTTER. And I thank the gentleman for that. I thought 

you might want to say they ought to take a look at the value of 

their homes, which had dropped like a rock. And because there has 

been some effort to stabilize and grow the economy again, really 

only on the backs of monetary policy, that they can look at their 

house and see some value returned to their house that fell like a 

rock in 2008 and 2009 and 2010. That is where I thought you 

might go. 

Mr. POSEN. That is better. 

Mr. PERLMUTTER. I appreciated a couple of words that were used. 

Dr. Lachman, you used one, and, Dr. Makin, you used one. One 

was ‘‘humongous.’’ I understand the word humongous. And the 

other was extemporize. And, through this recession, crash, fall on 

Wall Street, whatever you want to call it, we saw some constrictions in the stock market and in the financial market that we 

hadn’t seen at least—maybe ever, but certainly not since the Depression or before then. It was a different kind of a constriction. 

And I appreciated the comments of all the panelists that some 

very difficult steps, some new steps were taken by the Federal Reserve, as well as a number of the other central banks, because they 

are looking at the whole economy crashing. And then it is like, 

18 

price stability, we saw prices drop in 2008 and 2009, certainly in 

the real estate market, and in other markets, oil and gas. It went 

from $4 during the summer of 2008 in Colorado down to about $2 

or less. 

So I guess I would ask just as a general comment, and I know 

all of you were focused on this, have we as legislators, where we 

really have not had much of a fiscal policy over the last 2 years 

except for a very contractionary fiscal policy, and we put restraints 

on our Federal Reserve, have we done the right thing? And I will 

start with you, Dr. Posen, but I definitely want to get to the other 

gentlemen to get their response. 

Mr. POSEN. I should defer to the other people’s time. Just quickly, we have basically done the right thing. It doesn’t fix everything. 

It doesn’t fix everyone. But putting the restrictions on means when 

the next crisis hits outside the housing market, we are not going 

to be able to respond to it, and you are just going to have very indirect means of responding to it. 

Mr. PERLMUTTER. Dr. Makin? 

Mr. MAKIN. Yes, let me pick up on the word ‘‘extemporize.’’ A financial crisis presents policymakers with unprecedented problems. 

We have seen a combination of measures undertaken by the Fed, 

as well as fiscal stimulus packages undertaken by the Congress. 

Putting it all together, the outcome is okay, the best, actually, 

among the industrial countries. 

Mr. PERLMUTTER. And looking at your graphs, I think your 

graphs verify that or support that. 

Mr. MAKIN. Right. We have had about 2 percent growth without 

a lot of inflation. The employment picture hasn’t improved a lot, 

but that is partly because of some major changes that have occurred in the labor market. But so we have extemporized in a difficult situation and done better than most industrial countries. We 

certainly do need to do better. And we will eventually need to 

abandon these extreme policies, as the Congress has already done 

on the fiscal side. It just takes a very cautious and gradual approach. 

But for example, if we were to want to abandon the quantitative 

easing and the zero interest rate policy, interest rates would shoot 

up, the stock market would collapse, owners of bonds would get a 

higher return on their savings, but they might be faced with substantial wealth losses in terms of the value of some of their other 

assets. So we are in a difficult period now, but so far we have extemporized and done reasonably well. 

Mr. PERLMUTTER. Dr. Orphanides? 

Mr. ORPHANIDES. Thank you. 

Central banks are incredibly powerful institutions, especially 

during crises when using the balance sheet of a central bank can 

paper over a lot of problems that you wouldn’t have thought about 

that could be done during the crisis. 

I am worried that with the additional restrictions that have been 

placed on the Federal Reserve in light of the actions that they took 

in 2008, the Federal Reserve may be overly constrained. And because of the need to coordinate with the Treasury, and in some instances with Congress, the additional delay might actually create 

19 

problems if we had a crisis such as the one we had in 2008. That 

is the concern. 

Mr. PERLMUTTER. Thank you, Doctor. 

And I’am sorry, Dr. Lachman, that I didn’t get to you. Maybe one 

of my colleagues can let you respond. Thanks. 

Thanks, Mr. Chairman. 

Mr. HUIZENGA. And my apologies to my friend from Colorado for 

totally being the deer in the headlights and blanking. So, 2 years 

of being directly next to each other and I am blank. 

With that, we are going to go to Mr. Mulvaney for 5 minutes. 

Mr. MULVANEY. Thank you, Mr. Chairman. 

Gentlemen, I will read you a statement from last year’s meeting 

of the Joint Economic Committee. It says, ‘‘With respect to employment, monetary policy as a general rule cannot influence the long 

run level of employment or unemployment.’’ That is a true statement, isn’t it? That is economic orthodoxy, correct? Does anyone 

disagree with that? 

Mr. MAKIN. I will jump in. I essentially agree with that, that 

what monetary policy can do is to move employment increases forward, but they tend to get lost. 

Mr. MULVANEY. I think the general consensus is they can affect 

short run, but not long run. 

Dr. Posen, you had a look on your face like maybe you disagreed 

with that statement. 

Mr. POSEN. I disagree slightly, sir. If you go to the most recent 

paper issued by the Federal Reserve by Mr. Wilcox and co-authors— 

Mr. MULVANEY. I am familiar with it. 

Mr. POSEN. —it talks about the idea of hysteresis, that if you 

have a negative shock it could become self-fulfilling; that people 

who are out of work for a long time don’t get to get back into work 

at the same rate, say, of a young person. We saw monetary policy 

have a positive lasting effect on employment in the mid-1990s. We 

had welfare reform in the United States that increased the incentives for people to go to work. Monetary policy was allowed to run 

hotter for longer than it normally would have under the leadership 

of Chairman Greenspan. The unemployment rate dropped much 

lower than what people thought the limit was because of that. So 

under certain conditions, I think it can matter. 

Mr. MULVANEY. All right. There is another quotation I will read 

very briefly: ‘‘In the longer run, increasing the potential growth of 

the economy, that is not really the Fed’s job. That is the private 

sector’s job and Congress’ job in terms of things like the Tax Code, 

investment, infrastructure, and training.’’ That is Chairman 

Bernanke. Both of those quotations are from him. 

So my question to you is this: Why are we one of the only two 

countries that has the dual mandate? Is it because it is economic 

orthodoxy that you cannot impact—the Chairman of the Federal 

Reserve says that we cannot impact long-term employment with 

monetary policy. Yet, it is our mandate. And that is what I don’t 

understand. Why are we one of two countries that has the mandate 

when we know that monetary policy can’t influence it in the long 

run? 

Dr. Lachman? 

20 

Mr. LACHMAN. I think one really has to be cautious. One really 

doesn’t want to have a single mandate that you pursue with great 

vigor to the exclusion of what you are doing to the economy. That 

really gives the incentive for being too vigorous in the pursuit of 

the inflation. And I would just take a look at the European experience, where the single mandate right now is leading them down a 

path towards deflation— 

Mr. MULVANEY. No, I don’t know about that, because I went on 

to ask Dr. Bernanke on a similar line and what he told me was 

very clear. It is actually consistent with what Dr. Posen said earlier today, which is that the activities of the Fed over the course 

of the last several years since the crisis would have been essentially the same, because you could have undertaken the same policies for the last 4 or 5 years in the name of fighting deflation. We 

happen to be saying we are doing it in pursuit of full employment, 

or close to full employment, but really without the dual mandate, 

the Federal Reserve would have undertaken the same couple of 

steps. So I understand that. 

I am just worried about the situation where those two things diverge. And that is what the paper is about, are we going to tolerate 

higher inflation in the future in order to pursue this lower rate of 

employment? And I guess my question is, why would we do that 

if we know that we cannot impact long-term employment. 

But I am going to move on to my question, because Dr. Posen 

said some very interesting things in his testimony, his written testimony about limiting the tools. If I can very quickly recognize, we 

have a minute to cover two very important things. Limiting the 

tools. Should we limit some of the tools? If Detroit comes to Congress and asks for us to lend them money and we tell them no, 

shouldn’t we restrict the Federal Reserve from participating in 

that? Wouldn’t that be crossing the line into fiscal policy? 

Mr. POSEN. Yes. But I am not sure you need to restrict it in advance. I think you can afford to wait and then call up the chairperson and say you made a bad judgment there, I wish you hadn’t 

done that. 

Mr. MULVANEY. Fair enough. I guess the cows are a little bit out 

of the barn after that, though, aren’t they? 

Mr. POSEN. No. Because just as happened in Japan, sir, you can 

make a major change. Obviously, it is like with the military, like 

with the FDA, at some point you let them do their job, and if they 

don’t do their job right then you hold them accountable. You have 

to allow for that. 

Mr. MULVANEY. Secondly, and I am sorry to cut you off, you recognize the fact we are limited on time, you mentioned indemnifying 

the Fed against the losses. Your paper says that of course they 

have made so much money over their lifetime that they would 

never eat into that surplus. I think it was actually a Bloomberg report recently that projects could lose as much as $537 billion, 

which would absorb all of the money that they have made. Tell me 

again how this indemnification would work. I am not familiar with 

that. 

Mr. POSEN. Thank you. I will just be very quick. What has happened in the U.K. and a few other places is they say the balance 

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21 

ment, as it should. And we reckon those at a set term, whether it 

is once a year, once every 2 years, once every 6 months. There is 

a fixed, transparent term that doesn’t get played with. 

If in the operation of your duties, not just benefiting Detroit because you happen to have a Governor of the Fed from Detroit, but 

in the operation of your general duties you take a loss on the balance sheet, there will be some buffer of the Fed’s capital. You don’t 

want to have that go to zero. It doesn’t really matter if it does in 

economic terms, but it is seen as a problem. And so the Treasury 

or the Congress would say if that capital drops below a certain 

number, we will replenish it. 

Mr. MULVANEY. Thank you, sir. 

Mr. HUIZENGA. The gentleman’s time has expired. 

With that, we go to Mr. Carney of Delaware for 5 minutes. 

Mr. CARNEY. Thank you, Mr. Chairman. 

And thank you to each of the witnesses for being here today. 

This is a very interesting conversation. But I think at the end of 

the day the question is what is the role of Congress, what is the 

role of elected officials? Dr. Posen, you said that elected officials 

should set the goals and then check for results. And we have been 

talking, Mr. Mulvaney has been talking about the dual mandate of 

price stability and employment. Is there a general agreement 

among the panelists that ought to be the goals for the Fed? 

Mr. MAKIN. Price stability and employment? 

Mr. CARNEY. Yes. 

Mr. MAKIN. I would disagree. I think I indicated earlier that 

price stability is something the Fed can achieve. There is not much 

evidence to indicate that they can achieve either a long-term reduction in the rate of unemployment or a long-term increase in the 

rate of employment growth. 

Mr. CARNEY. How do you answer Dr. Lachman’s answer to the 

last question, where he said if you get overboard like the European 

central banks have recently, you very negatively affect employment 

and the economy? Dr. Makin? 

Mr. MAKIN. I am not quite sure that I understand Dr. Lachman’s 

point. In other words, what the central bank is responding to in 

that type of a situation, it seems to me, based on what was happening in 2008, is the situation in the asset markets where you 

have a threat to the functioning of the financial system. So they 

are stepping in to try to sustain the financial system. 

Mr. CARNEY. Okay. Fair enough. 

How about the other two gentlemen and then Dr. Posen? 

Mr. ORPHANIDES. If I may provide my response as well to Dr. 

Lachman’s remark earlier on, I think that with regard to the euro 

area, we should not confuse what is happening, that is quite dramatic and unfortunate, as a failure of monetary policy. Unfortunately, it had nothing do with monetary policy. Monetary policy 

cannot fix it. We have a governance problem where the States are 

essentially fighting with each other and do not coordinate in a 

proper manner, because really they do not have a Federal Government and they do not have the equivalent of the U.S. Congress 

that can hold things together. 

Mr. CARNEY. Okay. Fair enough. 

22 

Mr. ORPHANIDES. I would not really attribute to mistakes of monetary policy what we see in Europe. With that said, I would agree 

with Dr. Makin that in my view as well, price stability should be 

the primary objective of the central bank, because this is what they 

can be held accountable for. And then beyond that, I think what 

is critical for Congress is to watch the appointment process so that 

the independent officials who are appointed to make the tough decisions are the best possible. 

Mr. CARNEY. Okay. Fair enough. 

Dr. Lachman, how about you, where do you fall on this? 

Mr. LACHMAN. I would just say that Europe has just emerged 

from its longest post-war recession, that inflation in Europe has 

gone down to levels that are now threatening deflation, and the 

central bank has been very slow in either reducing interest rates 

or taking measures to improve the monetary transmission mechanism in Europe. So to me it looks like the European Central Bank, 

with its single-minded mandate of getting prices very low, is risking the economy in terms of deflation. 

Mr. CARNEY. So if you have a dual mandate, you are keeping 

your eye on two different things. And what does that require that 

central bankers do that mitigate against the severe kind of effect? 

Mr. LACHMAN. I guess if they have a balanced approach towards 

meeting their target. 

Mr. CARNEY. Thank you. 

Dr. Posen, would you like to weigh in? 

Mr. POSEN. Yes, really quickly. In an ideal world, it would be a 

dual mandate of price stability and avoiding excess volatility in the 

real economy, meaning huge swings in employment and growth, 

but not a level target for unemployment. I would still rather have 

Humphrey-Hawkins and the dual mandate as it is than a single 

mandate. I differ with Athanasios Orphanides on this. I think central banks that have the single mandate, I am echoing Dr. 

Lachman here, tend to become inflation nutters and not live up to 

their needed role. We also need to think about financial stability, 

whether it is said explicitly or not. Central banks have to worry 

about that. 

Mr. MAKIN. Could I add a quick— 

Mr. CARNEY. Sure. 

Mr. MAKIN. The problem in Europe is not so much the lack of 

a dual mandate as it is that the European Central Bank is the central bank for over 20 very different countries. 

Mr. CARNEY. So they effectively would have a difficult time affecting employment across those boundaries anyway. 

Mr. MAKIN. Their policy is fine for Germany; it is terrible for 

Spain. 

Mr. CARNEY. Thank you. Thank you all very much. I wish I had 

more time to carry on this conversation. 

Mr. HUIZENGA. The gentleman yields back. 

The Chair now recognizes Mr. Stutzman of Indiana for 5 minutes. 

Mr. STUTZMAN. Thank you, Mr. Chairman. 

I have really enjoyed this conversation. And I appreciate each of 

your perspectives. 

23 

Dr. Posen, you just made a comment, and I want to see if you 

could expound on it a little bit. You said price stability and then 

excessive volatility. Could you expound on that a little bit? Because 

I agree with you. I think certainty and stability is what is going 

to help middle income, help folks of lower income get to the next 

bracket, find the next rung on the ladder. Because right now that 

is what they don’t have. They don’t have certainty. Could you expound on that a little bit? 

Mr. POSEN. I will try, Congressman. And I know from your past 

proposals that you are concerned about uncertainty generated by 

monetary policy, and I respect that concern. 

Essentially what the issue is, as Dr. Orphanides on this panel 

and others have written about, is in the 1970s we made a huge 

mistake, as you are well aware, because we assumed there was this 

stable tradeoff between inflation and unemployment and that if we 

just were willing to accept higher inflation we would get lower unemployment. And that was doubly mistaken. First, we underestimated how costly the higher inflation would be. And second, we 

didn’t get permanent employment gains; we just got temporary 

ones. 

And so since that time there is a lot of academic work and a lot 

of policy work that has tried to get central bankers to not talk 

about employment at all. For various reasons that we have discussed, that seems to be something of a mistake. It takes it too far. 

But there is a truth there that if you target a specific rate of unemployment or you pretend that you can really control the unemployment rate through monetary policy, you probably are going to induce either inflation or uncertainty. 

So what I found in practice, and this is something we did at the 

Bank of England, and which other central banks have done in the 

past, is to say we may not know precisely what the rate of unemployment is, and we may not be able to push it to where people 

beg us to push it, but we can see when there is a big swing in the 

economy, a very rapid change, be it a runup because there is some 

uncontrolled boom, say, through a housing bubble, or a rundown 

like we had in 2008 because of a financial crisis, and the real economy, meaning real people, real businesses, real savers are being 

put through the wringer, we should try and offset that. And doing 

that in a short-term way should not conflict with price stability. 

Mr. STUTZMAN. Thank you. I appreciate that a lot. 

I would like to go to Dr. Orphanides. I would like to ask about 

some of the experiences that have developed under the European 

Central Bank, which is the most recent central bank that stood up 

a developed economy or economies. Given your experience on the 

ECB Governing Council, what did the architects look to when determining how to structure the ECB? And then also, did they look 

to existing central banks as a model? 

Mr. ORPHANIDES. Indeed, they did. And I have to say that I believe that the Federal Reserve did have an influence on the design, 

institutional design of the European Central Bank in two ways, 

both directly—the Fed is the closest they could look at in terms of 

a Federal institution that would bring together Federal Reserves, 

Federal Reserve banks, and the central banker in the middle, and 

coordinate this view—and also indirectly—so many of the elements 

24 

that the ECB drew on were from the Bundesbank that was set up 

in the 1950s. But the Bundesbank, when it was set up in the 

1950s, actually had a structure that also drew on the Federal Reserve. 

So the ECB did try, and the founders of the ECB did try to bring 

the best they could find internationally in their experience. Indeed, 

this is why they selected to have the lexicographic mandate that 

places price stability first, because this is what had been recognized as the state of the art when this was done in the late 1980s 

and early 1990s. And I believe that is still the state of the art. 

If I contrast that with the Fed, I think that the reason that the 

Fed has a dual mandate right now is simply because its own mandate was written in the 1970s, before we developed a consensus 

that suggests that focusing on price stability and helping central 

bankers not target real variables is best practice. 

Mr. STUTZMAN. If I could quickly, Dr. Makin, if you could comment on Japan’s QQE. Will it produce any different results from 

just the QE program in Japan? 

Mr. MAKIN. I believe it will. The Bank of Japan has frequently 

attempted to get out of their deflationary trap. And until this year, 

the bank was very conservative when they announced more aggressive asset purchases. They said, we will be very cautious, we are 

worried about hyperinflation, it probably won’t work. 

This year, the Bank of Japan, under new leadership, undertook 

to set an inflation target of 2 percent, which is very important to 

do when you are trying to end deflation, which is a very different 

game, and they have suggested that they will follow through until 

they achieve the goal. The ironic result I think that the Bank of 

Japan came to realize is that a necessary condition to end deflation 

is to promise inflation, a sufficient condition as to make it happen, 

and then have the presence of mind to throttle back when the inflation actually picks up. 

Mr. STUTZMAN. Thank you. I yield back, Mr. Chairman. 

Mr. HUIZENGA. The gentleman’s time has well expired. 

I do appreciate everyone’s charity as we are getting into some of 

these very important issues. And without objection, I think if the 

panel is willing to stay, we can maybe do another slightly quicker, 

if possible, lightning round of questions. I know I have some. And 

with that, I would like to recognize myself—and I don’t anticipate 

using the 5 minutes—but I will recognize myself for 5 minutes. 

Mr. Makin, I think I got your quote down, and I believe it was 

extemporaneous, I don’t think it was in your written testimony, but 

eventually we need to abandon these extreme policies—this is the 

Fed, as you are talking about—just as Congress has done fiscally. 

There are a number of us who might be concerned that we haven’t 

exactly abandoned our extreme policies on stimulus spending. In 

fact, we are having this debate right now dealing with unemployment going to be expiring at the end of the year, the extended 2 

years instead of the much shorter time of almost a year. We have 

had that with additional funding that went into nutrition programs, WIC, and others. 

And the political lesson that I have been learning out of this is 

that it is very difficult to extract out of that. And I think what you 

might have been hearing from Mr. Pearce and some of my other 

25 

colleagues is it seems like we are taking care of Daddy Warbucks 

on Wall Street, and with quantitative easing we are, I think as Dr. 

Posen was pointing out, oftentimes that might be the vehicle you 

need to make sure you have a strong financial center to let that 

all trickle down, but there are a lot of us I think who are questioning, can we ever really get out of that cycle? And I am curious 

how the Fed is going to extract itself out of a QA position when 

you see markets and Wall Street and maybe markets around the 

world say, oh, no, no, we can’t move off of $85 billion a month because that might mean we are going to have some movement here 

in a direction we don’t like in the short term. 

So if you care to answer that, and then Dr. Lachman, I would 

like you to, really quickly. 

Mr. MAKIN. Mr. Chairman, you have certainly hit the nail on the 

head in terms of the dilemma. When I was thinking of fiscal policy, 

I was thinking that in spite of many complaints the Congress has 

managed to reduce the budget deficit by about a third over the past 

year through a combination of the sequestration cuts and the tax 

increases. And I was thinking of that progress. 

The Fed’s problem is perhaps just as difficult. And as I mentioned earlier, it is highlighted by what happens in the marketplace when, as Chairman Bernanke did in May, they hint they 

might buy less, and interest rates go up and security prices go 

down, and everybody gets very nervous. So the short answer is I 

don’t know exactly how to do this. But neither does— 

Mr. HUIZENGA. I think part of the problem, exactly right, is that 

neither does the Fed. Now, we are caught in this hamster wheel. 

Mr. MAKIN. Nobody does. So I think in terms of being very practical, slowly and cautiously, and having reversibility as you go 

along, which is what I think the Fed is trying to engineer here. 

There is no book that tells you how to exit the Fed’s current strategy. 

Mr. HUIZENGA. Dr. Lachman? 

Mr. LACHMAN. Yes, I would agree that we are in uncharted 

waters. But I think a crucial point is that the longer that we delay 

the decision, the bigger the chance that we get asset price bubbles, 

credit bubbles. We are at some point going to have to exit. By delaying it, we just are going to make the exit all the more difficult. 

We have been to this dance a number of times before. 

So my fear is that if you keep printing $85 billion a month, and 

you have the Japanese printing $70 billion a month, what you are 

going to do is you are just going to create a very large asset and 

credit bubble that when you unwind it is going to be all the more 

difficult. So I think that you really have to be mindful that the benefits you get from the short run you might be getting at the price 

of large costs in the longer run. 

Mr. HUIZENGA. I think I will do this in writing, because, Dr. 

Posen, we only have a minute left. But I would love to get a reaction from you at some point of how you envision that we are going 

to pull this liquidity out. As Dr. Lachman is pointing out, Japan is at $70 billion a month, and we are at $85 billion a month. We don’t know what the ECB 

is going to do. But apparently they are prepared to do something 

as well. And how do we extract ourselves. 

26 

I do want to ask a very specific question, and maybe we can get 

some answers in writing as well on that. What are those reforms 

that you would like to see us do as we are approaching this 100th 

anniversary? I think it was Dr. Posen, I am not sure, but there was 

some discussion about an 8-year—is this what the European Central Bank—maybe it was Dr. Orphanides—European Central Bank 

you get an appointment for an 8-year period, and then you are cycled out, correct, you are done? That to me sounds like something 

that might be a positive. I am curious if anybody has a reaction? 

Mr. ORPHANIDES. There are two suggestions I would make. One 

is on the appointment process, that it would simplify and reduce 

the political battles we have right now with multiple rounds of potential appointments if you have a one-term, nonrenewable, longer 

term for all Board Members. Eight years is what is being done at 

the ECB. I think that would work better in the United States as 

well. 

The most important change, however, I think is to clarify the 

mandate. I am concerned that the lack of clarity of the mandate 

will be creating difficulties going forward precisely because we have 

the uncharted territory and the humongous, I think was the technical term used earlier, size of the balance sheet of the Federal Reserve. 

Mr. HUIZENGA. All right. Thank you. 

Mr. Carney is recognized for 5 minutes. 

Mr. CARNEY. Thank you. I am not sure I will need the whole 5 

minutes. But I do want to go back to— 

Mr. HUIZENGA. That is what I thought, too. 

Mr. CARNEY. —our discussion again. 

Not long after our discussion, Dr. Posen, you made an argument 

against the dual mandate I think when referring to the experience 

of the 1970s. Was that what that was? 

Mr. POSEN. It was an argument, sir, against setting a specific 

level of unemployment target. So, I am in favor of the dual mandate that there has to be concern for the real economy for growth 

and employment as well as price stability. 

Mr. CARNEY. Because it creates a sense of balance in the thinking of the Members? 

Mr. POSEN. Exactly. And it gives you room to respond to very 

large short-term fluctuations in the economy. And I would still, as 

I said to you, I would still rather have a dual mandate with an unemployment level than a single mandate. 

Mr. CARNEY. Great. 

Dr. Lachman, in your testimony you talk about the Lehman crisis and what you considered the effective response of the central 

banks and the Fed and how it avoided a global meltdown and a lot 

worse conditions than we saw. And you reference certain programs, 

including TARP. Have we eliminated tools that the Fed needs to 

address a crisis in the future? 

Mr. LACHMAN. I don’t know whether you have eliminated them, 

but I think that the Dodd-Frank Act might put certain limits on 

what they can do or that their room for maneuver isn’t quite as 

what it would be prior to the Lehman crisis. 

Mr. CARNEY. Notwithstanding some of the rhetoric in this committee, we can’t bail out banks in the way that was done in 2008. 

27 

There is an orderly liquidation process, as you may know, that 

banks are required to go through once it is determined that they 

are dying, I guess. Is that a good thing or a bad thing from the perspective of the broader economy? Forget about the politics of it. 

Mr. LACHMAN. My concern is that if we really do build up very 

large credit and asset bubbles, we have a chance that we are back 

into the kind of situation that we were at the Lehman crisis, in 

which case you would want a Federal Reserve that had wide capabilities of dealing with the mess when it occurred. 

Mr. CARNEY. Lastly, what should our role be as a subcommittee 

of Congress? Or what should Congress’ role be? Just, in a sentence 

or two each, each of you. 

Dr. Posen? 

Mr. POSEN. As I tried to say in my written testimony, which I 

apologize for delivering so late, I think Congress’ role should be 

very aggressive control of two things. First, what the stated goals 

of the Federal Reserve are, and changing those every couple of 

years as needed. Not, obviously, every day. That would be counterproductive. But as needed. And second, as I tried to say to the gentleman—sorry, I don’t remember what State you are from, I apologize. 

Mr. CARNEY. New Mexico. 

Mr. POSEN. Thank you. The gentleman from New Mexico, the 

Congressman from New Mexico, that you need to have much more 

retrospective accountability of holding Fed officials, did you do your 

job well or not? What specifically did you do? And are you accountable for that? But doing it in a holistic, retrospective way, not a 

starting off and saying there are things we want the Fed to do and 

not do. It has to be context and results based. 

Mr. CARNEY. Dr. Makin? 

Mr. MAKIN. Yes, I would like to see a directive for the Fed to 

pursue price stability, but not to ignore other goals. In other words, 

to emphasize that the Fed consistently pursues price stability and 

minimizes uncertainty, and thereby helps to improve the picture 

for employment and asset prices. In other words, I don’t think the 

Fed should be seen as saying, hey, we don’t care what happens. 

But they should be seen as saying, we want to continue to maintain low and stable inflation. There is a lot of empirical evidence 

to suggest that the economy performs better under those circumstances and that labor markets perform better as well. 

Mr. CARNEY. Dr. Orphanides? 

Mr. ORPHANIDES. I am a supporter of the primacy of price stability as an objective. And something we did not discuss sufficiently 

today, I believe, is that financial stability should be elevated as one 

of the explicit secondary mandates of the Federal Reserve rather 

than growth and employment. Those come naturally once you have 

price stability and financial stability. 

Mr. CARNEY. Dr. Lachman, a last word? 

Mr. LACHMAN. Yes. I agree with the way Dr. Posen posed the 

idea that the dual mandate should be working without a specific 

unemployment target. I am not sure that Congress should limit 

itself to retroactive review of the purchases that the Fed is doing 

given the scale of the purchases and given that it does have a disVerDate Nov 24 2008 16:55 Apr 17, 2014 Jkt 086685 PO 00000 Frm 00033 Fmt 6633 Sfmt 6633 K:\DOCS\86685.TXT TERRI
28 

tribution effect. I would think that Congress should have some 

input into those decisions. 

Mr. CARNEY. Thank you. 

Mr. HUIZENGA. The gentleman’s time has expired. 

With that, we will go to the gentleman from New Mexico, Mr. 

Pearce, for 5 minutes. 

Mr. PEARCE. Thank you, Mr. Chairman. 

So we began this process—and Dr. Lachman, I am probably 

going to come to you—of quantitative easing, printing money, 

whatever you are going to call it, and now it looks like we have initiated maybe that kind of an effect worldwide, that if it is good for 

us, everybody can do it. What are the downside effects of everybody 

beginning to create money out of thin air? 

Mr. LACHMAN. I think the reason that everybody has to do it is 

it does have impact on their currencies. That cheapens certain currencies, puts countries at a disadvantage. They will find themselves in the same position, so they go ahead with doing it. 

My view is that if all of us do this to a very large degree, and 

we have global financial markets, the risk is that what you get is 

you get global bubbles, and that when you begin withdrawing from 

that policy you are going to be paying a heavy price. I am not saying that quantitative easing wasn’t the right thing to do at the 

time that it was initiated. But I am saying that now that the balance sheets are so large and it looks like there is froth in the markets, I think that there has to be pause as to whether you just continue this indefinitely or do you start the process of unwinding. 

Mr. PEARCE. But then when we started unwinding we had one 

Member of the Federal Reserve saying at one point the same day 

we need to start tapering, and another Member of the Federal Reserve shrieked that we can’t start tapering. And so you get this 

mixed signal, and the markets are a little bit volatile. 

What is going to happen, Dr. Orphanides, if we get dropped as 

the world’s reserve currency? What will the effect of the quantitative easing be on the currency inside the United States? 

Mr. ORPHANIDES. I would put this in reverse. Of course, it would 

be catastrophic for the United States if the dollar loses the status 

of reserve currency. 

Mr. PEARCE. And so, it would be catastrophic. 

Mr. ORPHANIDES. This is one of the risks of continuously expanding the balance sheet of the Federal Reserve without having— 

Mr. PEARCE. If I can reclaim my time, it would be catastrophic. 

You can look at Argentina. They don’t have a currency. They can’t 

export inflation like we do. We get to export to 200 other countries, 

and so we diminish the effects inside. And so Argentina a couple 

of years ago had a 1,500 percent inflation rate, and so your statement that it would be catastrophic. So it really got my attention 

this year, maybe it was late last year, that the BRIC nations said 

they were going to start trading in other currency—Brazil, Russia, 

India, and China—and then two of them actually did that. 

So we are getting these warning signs from the rest of the world 

that you are creating some very unstable things with very catastrophic effects. We have started a printing war. And nobody 

knows the way out. Any hope? So what stops it all? Anyone? Dr. 

29 

Makin, I will just come to you next. Dr. Posen, I give you the last 

shot to wrap it up. 

Mr. MAKIN. There would be much more cause for urgent concern 

if we were seeing all this money printing and observing a big pickup in inflation. In fact, we are seeing the reverse, that inflation is 

actually slowing down. It is below 1 percent in Europe. It is about 

1.2 percent in the United States. And so, you have a deflationary 

situation that was kind of akin to what was happening in the early 

1930s, and central banks tend to want to export deflation by printing money, causing their currencies to depreciate, which means 

other currencies appreciate. 

So we have to avoid a kind of overt currency war of that type 

and at the same time try to get past a situation where everybody 

is using easy money to get a bigger piece of world trade. In other 

words, avoid a trade war, which is one of the things that made the 

Depression worse. 

Mr. PEARCE. Thank you. 

Dr. Posen, I assume that was your saying. You didn’t really have 

a comment to make on this. 

I guess the final thing is, what does this look like to the American family? My dad raised 6 of us on $2.62 an hour, the entry level 

in the oil field. Today, what his dollar would buy it takes $12 to 

buy. I think that is one of the reasons we are having such great 

stress in the American economy, that the value of what people 

make is being diminished radically by policies that the government 

is setting. 

I yield back, Mr. Chairman. 

Mr. HUIZENGA. The gentleman yields back. 

Seeing none on my over side of the dais here, we will go to Mr. 

Mulvaney for 5 minutes. 

Mr. MULVANEY. Thank you. 

Mr. HUIZENGA. And I should also announce we have just gotten 

notice that we will have votes at about 4:15. So if it is all right 

with you gentlemen, we will be wrapping up shortly after this 

round. 

Mr. MULVANEY. Thank you, Mr. Chairman. And thank you for 

the opportunity to do a second round of questions. 

Dr. Posen, this gives us an opportunity to spend a little more 

time on the last topic we had to sort of rush through at the end. 

I think I misspoke on a couple of numbers. And I want to give you 

the opportunity to speak at some length as well. We are talking 

about losses on the Federal Reserve’s balance sheet. I asked you 

previously about the concept of indemnification. I want to point out 

in your testimony the thing that caught my attention and re-ask 

my question. 

It is on page 10, the last paragraph: ‘‘Worries about losses on 

risky assets are nothing but a distraction. Whether the Fed temporarily loses money on a small portion of its portfolio or temporarily 

distorts a hypothetical pure market outcome for a particular asset 

class in service of that greater good should not be a constraint on 

doing the right thing.’’ 

You go on to close by saying, ‘‘And of course, the cumulative 

gains that the Fed has transferred to the U.S. Treasury over the 

30 

decades outweigh by two orders of magnitude any potential losses 

on the Fed’s balance sheet.’’ 

I guess we could have had a long conversation of a day about 

whether or not losses that the Fed faces now, the potential losses, 

and the number was actually $547 billion that Bloomberg estimated the Federal Reserve could lose in a higher interest rate environment, whether or not that is a temporary loss on a small part 

of its portfolio or whether or not we are simply seeing a temporary 

distortion in the pure market for, say, mortgages, or whether or not 

there is a larger, more significant distortion. 

I want to come to the issue about the cumulative gains and 

losses. The point that I was making is that I think of the cumulative gains last year, the combined earnings of the Fed, out of the 

combined earnings they were able to return back to the Treasury 

about $89 billion, $90 billion. And this is, as you mentioned, the 

case with other central banks, the policy, which is they take much 

of their combined earnings, they give it back to the Treasury. 

But now we are facing, and I had several Members of the Federal Reserve actually admit that they were facing the likelihood of 

large losses over a longer period of time. In a higher interest rate 

environment and a $4 trillion balance sheet, these losses could be 

substantial. Again, as Bloomberg estimated, on the order of half a 

trillion dollars. 

So I would ask you again to walk me through this process of indemnification. And I am seriously asking a question to which I 

don’t know the answer, which is a dangerous thing to do in Congress, but I have not heard that before. And I would like you to 

walk me through it. Maybe we can talk about it a little bit. 

Mr. POSEN. Thank you, sir. I will try to be responsive. 

Just one note on the numbers. I don’t remember the particular 

Bloomberg report you are discussing. You can create, and I don’t 

mean that in a bad way, you can on some reasonable assumptions 

create loss numbers that big. I would suggest that those loss numbers are pretty much the upper bounds. 

Mr. MULVANEY. I will tell you, and I don’t mean to cut you off, 

but I will tell you that we actually had witnesses in another hearing say that 100 basis points would lead to roughly $100 billion in 

losses. 

Mr. POSEN. That sounds about right. But again, you have to 

spread that over several years probably. But, yes. I think that is 

fair. 

So onto the point of the indemnification. The idea is not that the 

Congress and therefore the American people are writing a check to 

the Fed to fill up its balance sheet in total. 

Mr. MULVANEY. That is what it sounded like, so I am glad you 

went there first. 

Mr. POSEN. I tried to say, and I apologize for being unclear or 

too cryptic, there is a core level of the balance sheet, just like with 

a private business, that is essentially the Fed’s capital. It needs a 

certain amount of equity in order to conduct its operations. That 

amount is a tiny fraction of the $2 trillion balance sheet we now 

have. The Fed was able to do its operations back before 2008 with 

a balance sheet that was a very small portion of what it now is. 

Mr. MULVANEY. Balance sheet is $4 trillion, right? 

31 

Mr. POSEN. Sorry, $4 trillion. 

Mr. MULVANEY. $2 trillion, $4 trillion, pretty soon it is real 

money. Right. I get it. 

Mr. POSEN. The point being that all you would be indemnifying 

the Fed for is that it wouldn’t have to at some point under duress 

come to Congress or come to the executive and say, we have no 

money left in the kitty. 

Mr. MULVANEY. Can’t they just conjure it up? 

Mr. POSEN. They can, but that would be inflationary. And then 

also there would be room for people to say, oh, the Fed is a rogue 

entity. It is just making up its own policy. It is unconstrained. I 

think it is legitimate for Congress to have the control of saying we 

own, in some sense, the Fed. We own the equity. But the amount 

you need to identify, again, I want to stress this, is a very small 

amount. I don’t know what the exact number is, but it would probably— 

Mr. MULVANEY. If the Fed were to lose $100 billion, Dr. Posen, 

who loses that money? I understand who gains. They make $100 

billion, their combined earnings are $100 billion, they remit that to 

the Fed, the deficit goes down, the taxpayers are better off. When 

they lose that same $100 billion, who loses? 

Mr. POSEN. Unless and until they run out of money for their operations, on paper they lose that asset. Right? So the balance sheet 

of the Fed shrinks. And that is it. The balance sheet of the Fed 

shrinks. 

Mr. MULVANEY. Thank you. Again, I appreciate the opportunity 

for the longer discussion. Thank you, Mr. Chairman. 

Mr. HUIZENGA. I appreciate that. 

And with that, we will recognize Mr. Stutzman for the last 5 

minutes. 

Mr. STUTZMAN. Thank you, Mr. Chairman. 

Dr. Makin, I would like to come back to you about the Japanese 

policy and quantitative and qualitative easing. How is it that the 

Japanese Government can be so involved in the Bank of Japan’s 

policy decisions? 

Mr. MAKIN. The Bank of Japan is not that independent. And so 

the Prime Minister—it is a parliamentary government—was very 

clear when he was elected that he was going to appoint people at 

the Bank of Japan who would be very aggressive about pursuing 

an inflation target, and did appoint Mr. Kuroda, who promptly followed that line. So the Bank of Japan is obviously not independent, 

because we wouldn’t see in the United States, for example, a similar directive. 

Mr. STUTZMAN. Okay. 

Dr. Lachman, how does the Bank of England or the Swiss National Bank remain accountable to their national government if 

they are an independent entity? There has to be some sort of expectations and accountability between the two at some point, doesn’t 

there? 

Mr. LACHMAN. Absolutely. And Dr. Posen can probably talk better to it with the Bank of England. But the government is very 

much involved in setting what the goals are for the Bank of England in terms of an inflation target. And the Bank of England has 

to report at regular intervals on how it is doing with respect to the 

32 

inflation target. So you are granting them what one would call instrument independence, but you are setting for them what the 

goals are. 

Mr. STUTZMAN. And, Dr. Posen, if you would want to comment 

on this as well, because it just seems to be fascinating, especially 

even with the European Central Bank, the challenges that they 

would have within the European Union could be even greater. But, 

Dr. Posen, if you could maybe talk a little bit about the Bank of 

England and how their government relates to the different committees that they have structured? 

Mr. POSEN. Thank you. My colleague, Dr. Lachman, has it essentially right. There is an explicit inflation target set for the Bank 

of England. That target is set by the elected government. They can 

review it at any time, although for practical reasons of not wanting 

to seem too inflationary or too disruptive to markets, they generally review it every few years. 

Mr. STUTZMAN. And you mentioned that earlier. Is that something that appears to work for them? 

Mr. POSEN. A colleague of mine, Kenneth Kuttner from Williams 

College, and I just did a paper in which we showed that there is 

really no difference in inflation performance between central banks 

like the Bank of England, but not just the Bank of England, where 

the target gets reset by Parliament or the executive, versus central 

banks like the ECB, where you have very little control. It is just 

a question of legal structure. 

And if I may, I had the privilege to co-author with current Fed 

Chairman Bernanke a book on inflation targeting that came out 

back in 1999. And one of the main arguments we made for it was 

not to solely focus on inflation, because that would provide more accountability for the Fed. 

Mr. STUTZMAN. So you think that creates not only accountability 

for the Fed, but you think that by resetting they can refocus on 

what the environment is for the day. How often would they potentially or have they historically reset, maybe at the Bank of England 

or some other— 

Mr. POSEN. Let me give you just three quick examples. At the 

Bank of England, they have reset it approximately 4 times in 16 

years. One was a purely definitional thing. There was a particular 

inflation series. They switched the inflation series. Actually, it is 

only 3 times. And the most recent one was explicitly telling the 

bank not to worry about fluctuations in output as long as you don’t 

really imperil inflation. So, that was a change in focus. 

The Swiss National Bank, which is very independent, had a 

reset. There is a speech the current Swiss Bank Governor gave at 

our institute that is available on our Web site, they were facing, 

as I think Dr. Makin mentioned, huge capital inflows out of Europe 

that were driving up their currency and causing them deflation. 

And they explicitly changed their goal to doing with the exchange 

rate to try to keep a lid on that imported deflation. And that required parliamentary approval. 

Mr. STUTZMAN. Thank you. I find it very fascinating. 

I yield back, Mr. Chairman. 

33 

Mr. HUIZENGA. The gentleman yields back. And I, too, actually 

sat down with the Swiss Ambassador right about that time. And 

it was interesting. It was a flight of capital. 

Mr. POSEN. Yes. 

Mr. HUIZENGA. Flight of capital to something that was solid, the 

Swiss franc, and that was the reaction that they were having to 

deal with. 

All right. I would like to thank each one of our witnesses again 

for your testimony today. This was I think very helpful, very illuminating. 

The Chair notes that some Members may have additional questions for this panel, which they may wish to submit in writing. 

Without objection, the hearing record will remain open for 5 legislative days for Members to submit written questions to these witnesses and to place their responses in the record. Also, without objection, Members will have 5 legislative days to submit extraneous 

materials to the Chair for inclusion in the record. 

This hearing is now adjourned. 

[Whereupon, at 4:13 p.m., the hearing was adjourned.] 

(35) 

A P P E N D I X 

November 13, 2013 

36 


86685.001

Statement before the House Finaneial Serviee Committee's Subcommittee 

on Monetary Policy and Trade 

What is central about central banking? : A Survey of 

International Models 

Desmond Lachman 

Resident Fellow 

Ameriean Enterprise Institute 

November 13, 2013 

The vie;K~ expressed in this testimony (Ire those of the all/liar alolle (llltl do !lot 

necessari(l' represent those offlle American EIltcI11rise Illstitute 

1 
37 


86685.002

What is central about central banking? : A Survey of 

International Models 

Testimony for the House Financial Service Committee's Subcommittee on 

Monetary Policy and Trade 

Desmond Lachman 

Resident Fellow 

American Enterprise Institute 

November 13, 2013 

Thank you Chairman Campbell, Ranking Member Clay, and members of the 

Subcommittee for affording me the great honor of testifying before you today. My 

name is Desmond Lachman and I am a Resident Fellow at the American Enterprise 

Institute. I am here in my personal capacity and I am not here to represent the 

AEI's view. 

Introduction 

Over the past five years, in the aftermath of the Great Economic Recession, 

the Federal Reserve, the European Central Bank, the Bank of Japan, and the Bank 

of England have all pursued unorthodox monetary policies on an unprecedented 

scale. They have done so in an effort to stabilize their respective countries' 

financial systems and in an attempt to both support an economic recovery and to 

avoid deflation. This has led to a massive expansion in these central banks' balance 

sheets and it has taken monetary policy into entirely uncharted waters. 

There can be little question that unorthodox monetary policies were 

successful in stabilizing the major industrialized economies' respective financial 

systems in the immediate aftelmath of the September 2008 Lehman crisis. It also 

would seem that they have succeeded in providing welcome support to these 

economies' recoveries by substantially lowering long-term interest rates and by 

increasing asset prices. However, these policies havc come with a host of 

unintended consequences, including incipient asset and credit market bubbles, 

2 
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86685.003

which both e10ud the global economy's longer-run economic outlook and which 

must raise questions as to whether the limits of these policies' usefulness are now 

being reached. They have also had important spillover effects on other economies 

in general and on the emerging market economics in particular that now pose a real 

risk to the global economic outlook. 

Similarity and differences in policies 

Since September 2008, the motivation for the simultaneous pursuit of 

unorthodox monetary policies in the major industrialized economies has been 

broadly similar. All of these countries' central banks needed to intervene 

aggressively in their financial markets to repair the damage wrought by the 

Lehman crisis. In addition, with policy interest rales having effectively reached 

their zero lower bound and with unusually weak economic recoveries and very low 

innation, these central banks have all felt obliged to resort to policies aimed at 

stimulating the recovery. They have attempted to so by reducing long-term interest 

rates and increasing asset prices by massively expanding their balance sheets 

(Figure 1). 

While unorthodox monetary policies have led to a dramatic expansion in all 

four major central banks' balance sheets, there have been marked ditTercnces in the 

3 
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86685.004

manner in which these central banks have implemented their monetary policies. 

Underlying these difference have been basic differences in the structure of these 

countries' financial systems as well as in the specific problems that these 

individual central banks have been trying to address. Whereas in the United States 

and the United Kingdom the preponderance of bOlTowing takes place in the bond 

market, in Europe most borrowing is intermediated through the banking system. 

This explains why quantitative easing in the United States and United Kingdom 

has been effected through large scale bond purchases while in Europe the 

expansion in the ECB's balance sheet has been implemented mainly through bank 

lending. 

Beyond the common goal of supporting economic recovery, there have been 

differences in the specitlc additional problems that the individual central banks 

have tried to address. In the United States the Federal Reserve has tried to support 

the US mortgage market through large scale purchases of mortgage-backed 

securities; in Europe the ECB has taken fundamental measures to support the 

sovereign debt markets of countries in the European economic periphery; in Japan 

the primary objective of the Bank of Japan has been to put an end to years of 

deflation; and in the United Kingdom an important objective of monetary policy 

has been to encourage corporate borrowing. 

Institutional differences between the major economies would also explain 

why the major central banks have reacted to the crisis with the use of different 

policy instruments. As an example, although the ECB does enjoy at least as great a 

degree of policy independence as does the Federal Reserve, the Treaty of Lisbon 

highly circumscribes its freedom to directly finance member state governments. 

For this reason, the ECB has resorted to Long Term Refinance Operations rather 

than government bond purchases to support the economic recovery. 

These differences in in institutional structures and in specific objectives are 

reflected in the present main thrust of the unorthodox monetary policies as between 

the different central banks, which might be summarized as follows: 

• In the United States, since September 2012 the Federal Reserve has 

been engaged in an open-ended third-round of quantitative easing. This 

has involved the purchase of US TreasUlY bonds and mortgage-backed 

4 
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securities at a rate of US$85 billion a month. In addition, the Federal 

Reserve is providing forward guidance to the markets by indicating that it 

will not raise its policy rate so long as unemployment remains above 6.5 

percent and inflation expectations remain well anchored. 

• In Europe, since December 2011, the ECB has provided massive support 

to the European banks through its Long Term Refinance Operation 

(LTRO). This operation provided unlimited three-year financing to 

European banks against a widened definition of collateral. In addition, 

since August 2012, the ECB has provided major support to the European 

sovereign debt market through its Outright Monetary Transaction 

Program. Under this program, the ECB has offered to buy unlimited 

amounts of any member country's sovereign bonds with a maturity of up 

to three years, subject to that country applying to the European Stability 

Mechanism for an economic adjustment program. 

• In Japan, in April 2013, the Bank of Japan (B01) introduced a 

quantitative and qualitative easing (QQME) framework to end deflation 

and to achieve its 2 percent inflation target within two years. Under 

QQME, the BOJ aims to double its monetary base by 2014 to around 55 

percent of GDP. An important part of the QQME program was the 

broadening of monetary easing to include long-dated government 

securities and private sector risk assets. 

• In the United Kingdom, since January 2009, the Bank of England has 

engaged in quantitative easing that has involved bond purchases in an 

amount that has totaled around 25 percent of the country's GDP. In 

addition, in July 2012, the Bank of England, together with the UK 

Treasury, initiated a Funding for Lending Scheme, which aimed at 

reducing funding costs for banks and boosting credit supply. 

Assessing Unorthodox Policies 

Assessing the relative success of the unorthodox monetary policy pursued by 

the major industrialized countries is rendered difficult and subject to debate for two 

5 
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basic reasons. The first is that we cannot know what the counterfactual would have 

been had these policies not been pursued. The second is that it is still far too early 

to know what the longer run consequences of these policies will be since we do not 

yet know what will happen once these policies are unwound. 

Despite these caveats, as will be elaborated upon below, there are good 

reasons to believe that unorthodox monetmy policies have had a salutary short-run 

impact on both the individual economies concerned as well as upon the global 

economy. However, it would also seem that these policies have given lise to 

unintended consequences and to global spillovers, which must raise serious 

concerns about the longer run global economic outlook and which must pose 

questions as to whether the limits of these policies have now been reached. 

Short-run relative success 

In the immediate aftermath of the September 2008 Lehman crisis, central 

banks in the industrialized countries resOlied to a variety of bold and unolihodox 

measures with a view to restoring the proper functioning of the financial system. 

Subsequently, in response to the weakest industrial country recovery in the postwar period as well as to very low inflation rates, they resolied to different variants 

of very large-scale quantitative easing programs. They did so with a view to 

restoring aggregate demand by lowering long term interest rates, by encouraging 

risk taking, by increasing asset prices, and, although they would be the last to 

admit it, by cheapening their respective currencies. 

There is little room for debate about the major central banks' success in 

restoring the proper functioning of the global financial system. Through innovative 

programs such as TALF, TAF, TARP, SMP, and LTRO, bank access to liquidity 

was substantially eased. Further, by lending long-term without asking too many 

questions of the collateral they received and by buying assets well beyond their 

usual limits, the world's major central banks restored liquidity to a world financial 

system that would otherwise have been insolvent based on prevailing market 

pnces. 

There would also seem to be little room for doubt that the world's major 

central banks succeeded in lowcring long-term interest rates and in boosting asset 

prices. Long-term borrowing costs for both the government and the private sector 

6 
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86685.007

were reduced to post-war lows in the industrialized countries. At the same time, 

there has been an appreciable recovcry in global home priecs, while global equity 

prices have risen sharply from their post-Lehman lows to a six-year high. 

Two particular succcsscs of recent central bank intervention warrant 

mention. The ECB's Outright Monetary Transaction program announced in August 

2012 succeeded in substantially reducing sovereign borrowing costs in Europe's 

troubled economic periphery (Figure 2). It did so by removing the tail risk of an 

imminent Euro breakup though offering governments in the periphery with a 

credible financial backstop. Similarly, the Bank of Japan's more aggressive round 

of quantitative casing announced at end 2012 succeeded in substantially weakening 

the Japanese yen thereby increasing Japanese inl1ationary expectations. 

2 

Em'o ZmH! Homl Yi(!lds 

Despite the success of unorthodox monetary policies in reducing long term 

interest rates and in increasing asset prices, the economic recovery in the 

industrialized countries has been highly disappointing (Figure 3). While in the 

United States it is true that the cconomy has by now significantly surpassed its 

2008 peak, the current US economic recovery remains the weakcst in the post-war 

period. Meanwhile, output levels in Europe, the United Kingdom, and Japan are 

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86685.008

yet to regain their 200R level. Making matters worse in the United Kingdom is the 

fact that despite anemic economic growth, intlation has significantly exceeded the 

Bank of England's inflation target. 

Among the factors accounting for Europe's weak economic performance and 

clouding its longer nm economic outlook has been the breakdown of the ECB's 

monetary transmission mechanism and the absence of a banking union that might 

address the credit crunch hampering a recovery in Europe's economic periphery. 

While the ECB has now begun an asset evaluation exercise of the major Europcan 

banks, there is little immediate prospect of either bank recapitalization or of policy 

action to reduce the gap between borrowing costs in the European economic 

periphery and those in the European core. This now raises thc real spccter or 

denation especially in the European economic periphery. 

Critics of quantitative easing observe that the economic recovery in the 

industrialized countries is the weakest of the post-war period. While true, this 

criticism would not seem to be a serious indictmcnt of recent quantitutive easing 

policies. It overlooks the fuct that, absent forceful central bank action, it is highly 

probable that the industrialized countrics would have again lapsed into a 

meaningful economic recession (Figure 4). 

8 
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86685.009

USI 

Unintended consequences 

A more serious line of criticism of the unorthodox monetary policies being 

pursued by the world's major central banks is that too little regard is being paid to 

the unintended consequences flowing from these policies. These consequences 

could materially compromise the longer-Iun global economic outlook. Among 

these unintended consequences are (a) the risk that these policies might be giving 

rise to excessive risk taking and to bubbles in asset and credit markets; (b) the large 

spillovers to other economies through capital Hows and exchange rate movements; 

(c) the moral hazard that these policies might be causing by reducing the urgency 

for governments to undertake necessary but painful economic reforms; and (d) the 

risk that exit fi'om these policies might cause global tinancial market dislocations. 

An important aim of the quantitative casing policies pursued in the United 

States, the United Kingdom, and Japan has been to encourage risk taking and to 

raise asset prices as the means to stimulate aggregate demand. The question that 

now needs to be asked is whether these policies might not have given rise to 

excessive risk taking, to overleverage, and to bubbles in asset and credit markets. 

9 
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86685.010

In this context one has to wonder whether historically low junk bond yields in the 

industrialized countries now understate the risk of owning those bonds (Figure 5). 

One also has to wonder whether yields on sovereign bonds in the European 

periphery have not become disassociated from those countries' underlying 

economic fundamentals and whether global equity valuations have not become 

cxcessively rich. 

Over the past year, the aggressive Federal Reserve and BOJ quantitative 

easing policies has given rise to large scale capital flows and to significant 

exchange rate movements. The Japanese yen has depreciated by around 20 percent 

since the launch of Abenomics in December 2012, which has given rise to 

complaints about competitive cUlTency depreciation from countries like China and 

Korea. Meanwhile the Euro has appreciated by around 5 percent, which is hardly 

helpful to a European economy that is lhe worst performing or the major 

industrialized economics. 

Recent capital f10ws and currency movements have been particularly 

disruptive to the emerging market economies, which have been the main engine of 

global economic growth. These countries have had the greatest of difficulties in 

preventing these large capital inf10ws from causing their currencies to become 

10 
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86685.011

overvalued and their external cUiTent accounts to widen to unsustainable levels. 

These countries' vulnerability to a change in global liquidity conditions has been 

all too apparent in the wake of Ben Bernanke's intimation in May 2013 that the 

Federal Reserve might start tapering its bond purchase program. That intimation 

caused sharp cUiTency depreciations in Brazil, India, Indonesia, South Africa and 

Turkey, which prompted the IMF to significantly downgrade its economic growth 

forecast for the emerging market economies. 

Yet another unintended consequence of the unorthodox monetary policies is 

the moral hazard to which they are giving rise. This is patiicularly apparent in both 

Europe and Japan. Europe is not using the breathing space in its sovereign debt 

market that the ECB's Outright Monetary Transactions program has afforded it to 

move more expeditiously towards a banking union and a fiscal union that would 

seem necessaty to put the Euro on a firmer footing. Similarly, the very much more 

expansionary monetary policy by the Bank of Japan seems to be blunting the 

urgency for the Japanese government to move ahead with stlUctural reform which 

was supposed to be an important pillar of the Abenomics program. 

Lessons for the United States 

Since the Lehman crisis in Septembcr 2008, the US economy has performed 

relatively well in relation to those of the Eurozone, Japan, and the United Kingdom 

in terms of output and employment growth. Nevertheless it would seem that at 

least two lessons for the Federal Reserve can be drawn from the experience of the 

central banks in those countries: 

a. Europe's patiicularly poor economic performance in the aftermath of the 

Lehman crisis would suggest that a single inflation objective mandate 

and a high degree of central bank independence do not guarantee 

meaningful economic recovery. It would also suggest that financial 

market fragmentation imposes a high economic cost and that a single 

monetary policy not backed by a banking and fiscal union is a bad idea. 

b. Japan's prolonged experience with deflation over the past decade would 

underline the costs of too passive a monetary policy stance in the face of 

economic weakness. This point would also be supported by Japan's very 

11 
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86685.012

much better economic performance since the stmt of this year in response 

to a very much more aggressive Bank of Japan monetary policy. 

Equally pertinent lessons would seem to be on offer from the Federal 

Reserve's own unfortunate past experience from creating asset and credit market 

bubbles as well as from its previous experience in fighting inflation: 

a. In the period immediately ahead, the Federal Reserve will be confronted 

with the most difficult of policy choices. A lackluster economic recovery 

and very low inflation would argue in favor of maintaining the present 

pace of quantitative easing. Yet doing so would accentuate the longer-run 

unintended consequences of these policies that are already so much in 

evidence. One has to hope that the Federal Reserve will strike the right 

balance between the ShOlt lUn gains to be obtained from further 

quantitative easing and the 10nger-lUn adverse costs of those policies. In 

pmticular, one must hope that the Federal Reserve refrains from 

repeating its past mistake of unduly fueling asset and credit market 

bubbles as well as of contributing to undue exchange market volatility. 

b. From a 10nger-lUn perspective one also has to be concerned about the 

massive expansion of the Federal Reserve's balance sheet. In particular, 

one has to be concerned that the Federal Reserve will find it politically 

difficult to nOlmalize interest rates once an economic recovery eventually 

gathers steam. This has to raise serious concerns about the longer-term 

inflation outlook, which would argue in favor of ensuring that the Federal 

Reserve's independence to raise interest rates as needed is not 

compromised. 

c. The Fed's massive asset purchase program has had both important 

distributional effects amongst wealth owners and it has exposed the US 

taxpayer to considerable risk. One might reasonably question whether 

these Fed activities have been subject to sufficient Congressional 

sClUtiny. 

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Biography of Desmond Lachman 

Desmond Lachman is a Resident Fellow at the American Enterprise Institute 

(AEI). He joined the AEI after serving as a managing director and chief emerging 

market economic strategist at Salomon Smith Barney. He previously served as 

deputy director in the International Monetary Fund's (IMF) Policy Development 

and Review Department and was active in staff formulation of IMF policies. Mr. 

Lachman has written extensively on the global economic crisis, the u.S. housing 

market bust, the u.S. dollar, and the strains in the euro area. At AEI, Mr. Lachman 

is focused on the global macro-economy, global currency issues, and the 

multilateral lending agencies. 

Experience 

• Adjunct Professor, Georgetown University, 2010 

• Adjunct Professor, Johns Hopkins University, 2009 

• Managing Director and Chief Emerging Market Economic Strategist, 

Salomon Smith Barney, 1996-2003 

• Deputy Director, Policy Development and Review Department, International 

Monetary Fund, 1994-96 

• Senior Advisor, European Department, 1990-94; Division Chief, Western 

Hemisphere Department, 1984-90, International Monetary Fund 

Education 

Ph.D., economics, Cambridge University 

B.A., University of Witwatersrand 
49 


86685.014

Statement before the Committee on Financial Services 

Subcommittee on Monetary Policy and Trade 

On "What's Central about Central Banking?" 

Central Banking since the 2008 Global Financial Crisis 

John H. Makin 

Resident Scholar 

American Enterprise Institute 

Wednesday, November 13, 2013 

The views expressed in this testimony are those of the author alone and do 

not necessarily represent those of the American Enterprise Institute. * 

Thanks to Brittany Pineros for her able research assistance. 
50 


86685.015

Chairman Campbell, Ranking member Clay, and members of the committee I am pleased to 

offer testimony on practices of central banks since the great financial crisis of 2008. While the 

last S years has been a very challenging period for all central banks, a review of practices and 

outcomes will suggest that the Federal Reserve and the United States have performed very well 

relative to other countries based on yard sticks measuring economic performance. 

I will start with an overview of central bank practices since 2008, then review the practices in 

some detail, present a summary of economic and financial performance since 2008, and finally, 

discuss the policy dilemma facing some central banks. 

Overview 

Among major central banks, the Federal Reserve has been the primary innovator since the 2008 

financial crisis presented governments and central banks with serious challenges. Given the 

global reach of the crisis and the threats of deflation, persistent unemployment and low growth, 

and potential insolvency of banks and insurance companies, other central banks have, to varying 

degrees, followed the Fed's lead. 

The 2010-11 European banking crises arose after revelations that Greece, along with several 

other countries in the European Union, had been severely misrepresenting their fiscal problems. 

The challenges presented to the European Central Bank (ECB) were severe. Unlike the United 

States, the ECB is responsible for conducting monetary policy for the entire European Union, 

composed of 28 disparate economies, each with its own separate and independent finance 

ministry. The right monetary policy for Germany is not the right policy for Greece, Spain, or Italy, 

to mention only the most prominent examples of countries approaching outright deflation 

because of a toxic, for them, combination of ECB's stringent monetary policy and fiscal austerity. 

Japan and Switzerland have also faced challenges springing from deflation pressures that have 

required them to employ aggressive monetary measures in order to avoid persistent currency 

appreciation that would at once symbolize and exacerbate the problems they face. In effect, 

both have taken measures to avoid importing deflation pressure, a more useful description of 

the impact of currency appreciation. 

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The Bank of Japan (BOJ) with a longer standing (15 year) deflation problem has been more 

innovative than the Swiss National Bank (SNB), relying more, especially since early this year, on a 

combination of aggressive quantitative easing coupled with forward guidance of the sort 

engineered by the Fed since 2010. 

Both the SNB and the People's Bank of China (PBOC) have instead relied heavily on direct 

currency intervention, large purchases of foreign exchange (especially dollars in the case of 

China and Euros in the case of the SNB) to avoid the deflationary impact of substantial home 

currency appreciation. China's intervention has resulted in its widely-noticed surge in foreign 

exchange reserves, at $3 trillion and counting, a substantial portion of which has been employed 

to purchase US treasury securities. That outcome has benefited both China and the US. China's 

need to store trillions of dollars worth of foreign exchange reserves, to prevent appreciation of 

its currency, has been accommodated by the US, which in turn has benefited from substantially 

lower borrowing costs. The surge in US borrowing from China since 2008 has accommodated 

trillion dollar plus budget deficits, incurred in part to finance programs of fiscal stimulus. 

The balance of my testimony, in response to Chairman Campbell's direction, summarizes the 

post-crisis policy tools of major foreign central banks, benchmarked against the Fed's post-crisis 

policy innovations and track record. Overall, the Fed's post-crisis performance compares 

favorably with other central banks in a very difficult economic and financial environment, where 

no nation has regained pre-crisis financial levels. 

Central Bank Tools and Goals 

Table 1 summarizes the tools and goals of six major central banks which are actively involved in 

managing the financial crisis. 

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Table 1. Central Bank Tools and Goals 

Central Bank 

Instrument Federal European Bank of Bank of Swiss People's 

Reserve Central Japan England National Bank of 

Board Bank (BOJ) (BOE) Bank China 

(FRB) (ECB) (SNB) (PBOC) 

1. Zero Interest Yes, pushed Cut rate to Overnight Bank rate at Yes No, current 

Rates/Zero policy rate 0.25% on call rate at 0.5% rate at 6% 

Bound to zero in Nov 7, 0.5% 

early 2009 2013 

2. Quantitative Yes, in three No Yes, Apr Yes, Mar Yes, to Yes, large 

Easing (QE) stages, Aug 2013 to 2009 to counter 2008-09 

2010,Aug present present currency credit 

2011, Sep appreciation expansion 

2012 

3. Large Scale Yes, TARP in Yes, since Yes, asset Yes, asset No No 

Asset Purchases Q42008 July 2009 purchase purchase 

(LSAP) program, facility, Jan 

Nov 2010 to 2009 to 

Mar2013 present 

4. Currency No UNo!! Yes Yes Yes, heavy Yes, heavy 

Market 

Intervention 

5. Forward Yes, date- Yes, Draghi Yes Yes, Aug Yes, No 

Guidance based in Aug declared 2013 to aggressive 

2011 would do present on currency 

and "whatever 

state-based it takes" to 

since Dec preserve 

2012 the euro in 

July 2013 

6. Goal 

Targeting 

a. Inflation Yes, 2% No Yes, 2% Yes, 2% Avoid Avoid 

target target since target deflation inflation 

Apr 2013 

b. Price level Flexible No No Flexible No No 

inflation inflation 

target target 

c. Yes No No Yes No Yes 

Unemployment 

or economic 

growth 

Sources. Federal Reserve Board, European Centra! Bank, Bank of Japan, Bank of England, SWISS National Bank, and People 5 Bank of 

China websites. 

Federal Reserve 

Shortly after the lehman Brothers crisis, the Fed, along with the Treasury, pressed aggressively 

for a large liquidity injection into the banking system, known as TARP, while following through 

3 
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with a reduction of its policy rate virtually to zero by early in 2009. Thereafter, the Fed 

undertook large purchases of treasury securities and mortgage-backed securities in three stages 

beginning in August 2010, with the second round in August 2011, and finally, QE3 beginning in 

September 2012 which included a specific commitment to purchase securities. 

In a sense, quantitative easing and the large-scale asset purchases, employed by other central 

banks, are quite similar as they both involve the central bank purchasing securities in the open 

market in an effort to inject liquidity and stimulate the economy. 

Currency market intervention has not been employed by the Fed, rather, the US stance on 

currency has been a passive one, allowing the dollar to reflect intervention and market 

pressures emanating from the global economy and the efforts of other central banks. 

Since August 2011, the Fed has pioneered forward guidance, an effort to underscore and clarify 

its commitment to achieving its goal of keeping inflation steady while reducing the rate of 

unemployment. The initial efforts were date-based, indicating that policy would remain highly 

accommodative for the indicated period. Subsequently, in December 2012, "state-based" policy 

was introduced, indicating that interest rates would be held at zero until the unemployment 

rate dropped to at least 6.5 percent. 

The Feds goals are, explicitly, 2 percent inflation and minimizing the unemployment rate with an 

eventual target of reaching a rate consistent with price stability, the so-called natural rate of 

unemployment. Estimates suggest that the natural rate of unemployment is somewhere 

between 5 and 5.5 percent, considerably below the current unemployment rate of 7.3 percent. 

European Central Bank 

Broadly, the ECB was slower to respond to the crisis, for feeling at first that it was largely 

confined to the US since it had originated with the collapse of a US-based investment bank, 

Lehman Brothers. However, late in 2009, with revelations that the Greek government had been 

seriously underreporting its deficits and debt, the European financial crisis began. 

4 
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86685.019

The major tool employed by the ECB to combat the financial crisis was, along with actions by the 

European Finance Ministry, large-scale asset purchases which have been underway since luly 

2009. Europe endured a very volatile period in 2010 and 2011 as governments struggled with a 

Greek solvency crisis that became a solvency crisis in much of southern Europe. In luly 2012, 

ECB Chairman Draghi indicated that he and the ECB would do "whatever it takes" to avoid a 

financial crisis and collapse in Europe. The remarks, underscored by successful efforts in the US 

and combined governments of Europe, had the effect of calming European financial markets. In 

April 2013, the ECB added forward guidance to its effort to stabilize and sustain recovery by 

suggesting that its highly accommodating stance would be maintained for "an extended period". 

The ECB has a mandate to maintain price stability above all other goals with no explicit 

reference to growth or unemployment. 

Bank of Japan 

The BOl has struggled with persistent deflation for nearly 15 years. Starting earlier this year with 

the new Abe government, the BOl moved aggressively to adopt a program of quantitative 

easing, even more aggressive than that pursued by the Fed in terms of the pace of increase of 

the BOl balance sheet. Prior to that, it had maintained an asset purchase plan designed to 

support the economy and financial markets through the purchase of a range of assets including 

government bonds and some equities. 

The BOl has also intervened in the currency market to prevent appreciation that would add to 

its deflation problem. It has also offered forward guidance insofar as it has committed to 

reaching a goal of 2 percent inflation over a period of about 2 years. BOl has no explicit 

unemployment target but its general goal is to improve economic performance by arresting 

deflation. 

Bank of Eng/and 

The Bank of England (BOE) dealt with intense solvency issues during and after the financial crisis. 

Northern Rock, a financial institution, perhaps akin to a savings and loan institution, actually 

experienced a run on its assets, which was arrested by aggressive liquidity provisions from the 

BOE. The BOE has pursued substantial asset purchases since March 2009 to help support the UK 

5 
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86685.020

economy and financial markets. Starting in August of this year, the BOE became more explicit 

about offering forward guidance with respect to its conduct of monetary policy. The BOE targets 

inflation and more recently has embraced the UK Treasury's notion of a "balanced approach" to 

obtaining a flexible inflation target. 

Swiss National Bank 

The SNB's primary problem has been currency appreciation and its deflationary effect. During 

the European financial crisis, the pressure to move off the euro and onto the Swiss franc as a 

safe haven currency was substantial, forcing the SNB to purchase large quantities of euros in 

order to avoid debilitating currency appreciation and deflation. Judging by the performance of 

the Swiss economy, to be seen below, the efforts were largely successful. 

People's Bank of China 

The PBOC has largely pursued an intervention policy to prevent currency appreciation. As a 

result, it has required substantial foreign exchange reserves, over $3 trillion worth, much of 

which, as indicated above, is invested in US treasury securities. The PBOC has not been 

particularly innovative with respect to zero interest rates policies, quantitative easing, or 

forward guidance. It has relied instead on a massive fiscal stimulus program, engineered in late2008 and early-2009, to avoid a negative feedback from the financial crisis and economic 

slowdowns occurring elsewhere in the world. 

Outcomes 

Figures 1 through 4 summarize the performance of most major economies since 2008. 

Figure 1 shows the path of real gross domestic product (real GDP) since 2008 for 7 economic 

regions. After dipping in 2009, most economies, with the exception of Spain, have followed an 

uneven path of rising output. By the third quarter of this year, the US economy was about 8 

percent above its level in 2008, the best performer of the group. Switzerland performed nearly 

as well, reaching a level of about 7 percent above the 2008 level, while Germany and Japan 

recovered to levels of about S percent above their 2008 benchmark. The UK's recovery has been 

substantially more modest, and overall, the European Union has been static since 2008. The 

6 
56 


86685.021

performance of Spain, indicated on the chart, Italy, Greece, and other southern European 

economies was dragged down by stringent fiscal austerity and tight monetary policy. 

Figure 1. Real Gross Domestic Product 

110 

Source: OrgaAization for Economic Co·operation and Development, Quarterly National Accounts statistics 

Notes: Gross domestic product, expenditure approach, constant 2005 prices converted with 2005 PPPs, annual !eve!s seasonally 

adjusted. All countries normalized with 04-2008 equal to 100. Quarterly data not available for China. 

Figure 2 shows the inflation experience of most major countries since 2008. The US has 

experienced modest inflation with a total price increase of 9 percent over the S-year period. The 

European Union, taken together, has experience a price increase of about 10 percent, while 

Spain and Germany's price increase has been more modest, at about 8 and 7 percent 

respectively. Switzerland and Japan have experienced modest deflation with Japan's price level 

falling a cumulative 2 percent over the S-year period, while the Swiss price level has been 

virtually unchanged, partly due to the aggressive intervention efforts of the SNB to avoid further 

deflationary appreciation of the Swiss franc. 

7 
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86685.022

Figure 2. Consumer Price Index: All Items 

uo 

S 

c 

... 

II 105 

~ <:> 

N 

~ ., >< 

'1:1 

.5! 

Sources: Bureau European Eurostat. 

Japan, China, Germany, Spain, Switzerland, United Kingdom country data are available from the Organization for Economic Cooperation and Development, Main Economic Indicators database. 

Notes: US measures Consumer Price Index for all Urban Consumers. European Union measures Harmonized Index of Consumer 

Prices, AI! Items for European Union (28 countries), All other countries measure Consumer Price Index, All Items for Country. All 

countries normalized with Q4-2008 equal to 100, 

Figure 3 shows the employment experience of the major economies over the past 5 years. The 

US is in the middle of the pack, with the number of employees at mid-year 2013 having just 

reached the level experienced in 2008. The negative outlier is Spain, with employment 15 

percent below its 2008 levels, a victim of a too-tight monetary policy and substantial fiscal 

austerity. German employment has risen about 3percent since 2008, while UK employment has 

been about static. Overall the European Union has experienced about a 3 percent drop in 

employment since 2008. 

8 
58 


86685.023

Figure 3. Total Employees 

110 

105 

100 

95 

90 

85 

European country data is from 

Eurastat. Japan data is available from the Organization for Economic Co-operation and Development, Main Economic Indicators 

database, 

Notes: US measures All Employees, Total Nonfarm. European countries measure Total Employment (resident population concept) 

from the EU-LFS. Japan measures Total Employment by Professional Status, Employees for Japan. All countries normalized with Q4-

2008 equal t~ 100, except Switzerland where 01-2010 equal to lOa. Quarterly data not available for China. 

Figure 4 shows the performance of major stock markets since 2008 as a way to suggest the 

stabilization of the economic outlook in the financial sector. German and American stock 

markets are performing the best, having risen by about 100 percent over the past 5 years. 

Japan's stock market is in third place, having risen about 70 percent, with a rapid catch-up since 

the end of last year given the onset of Abenomics, aggressive easing by the BOJ, and 2 percent 

inflation targeting. A promise to end deflation can be very helpful to stock markets. The British 

stock market has risen by about 60 percent while the Swiss market has risen by about 45 

percent. lagging markets include Spain's IBEX 35 Index with a modest recovery of only about 15 

percent and the Shanghai stock market, which after a rapid run up in 2009, has trailed off to a 

cumulative increase, since 2008, of only about 10 percent. Overall the European stock market, 

the right benchmark for the effect of ECB policies, is up about 25 percent, dragged down by the 

weak markets in southern Europe. 

9 
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86685.024

Figure 4. Closing Stock Prices 

50 eo c;- c;- c;- c;- o 0 0 0 .... ,... rl .... N N N N M M M M 0 0 0 0 0 .-< rl ,.., ,.... rl M .... ,.., ,... '""' ,..; ..-I ,..., '"' ,.... ::. 1:, ~ M ::. 1:, '" M :> 1:, ;", M . 1:, '" !if >. 1:, ~ :> M >. 

" '" '" " III '" '" " " '" '" " ~ '" " " :::J Z ... :::;: ..: z ... :::;: ..: z ... :::;: ..: z :::;: ..: z ... :::;: ..: z " 

Source: 

Notes; Daily stock closing prices averaged over the month. All country stock indices normalized with November 2008 equal to 100. 

Summary 

The difficult period since 2008 has seen widely-varied practices of central banks and widelyvaried performance of economies and markets. Overall the Fed's performance is among the 

best, both measured in terms of the degree of innovation and in terms of economic 

performance - increased output and moderated inflation. 

Employment has disappointed in most areas, with the US achievement of the 2008 employment 

level just this year about average for the sample investigated. The best performance came in 

Switzerland, which was not largely affected by the financial crisis and took preemptive 

interventions to prevent currency appreciation. Countries like Spain, shown on figure 3, suffered 

badly from ECB policy choices that were correct for Germany but too tight for southern Europe. 

Fiscal austerity imposed on southern Europe also took its toll. Employment charts of Italy, 

Portugal, and Greece would look just-as-bad or worse than Spain's. 

10 
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86685.025

Policy Dilemmas Persist for Central Banks 

Central banks face two major issues as we enter the sixth year of the post-crisis period. The first 

is the bubble dilemma. The second is th~ risk of deflation, or the deflation dilemma. These two 

dilemmas pull central banks in opposite directions. The bubble dilemma, or rising prices of 

financial assets resulting from quantitative easing (QE), raises pressure to withdraw stimulus, as 

in the case of the May through September Fed "taper trauma". The deflation dilemma, or falling 

prices of goods and services, creates pressure to add stimulus, as in the case of the ECB's 

controversial November 7 decision to cut its benchmark lending rate by 25 basis points to 0.25 

percent. 

The ECB rate cut was driven largely by a report that Europe's year-over-year core inflation rate 

had fallen to 0.8 percent in October, well-below the informal ECB medium term inflation target 

of 2 percent and perilously close to zero. European stock and bonds rallied sharply after the ECB 

rate cut, leading six members of the ECB's 23-member governing council to complain, plausibly, 

about the increased risk of financial bubbles and, implausibly, about the increased risk of 

inflation of goods and services prices. 

QE experiments have left central bankers facing a dilemma. If QE is pushed too far, inflation will 

eventually emerge in markets for goods and services, though none is yet evident. In October, 

the IMF World Economic Outlook estimated inflation for advanced economies at 1.4 percent in 

2013, down from predictions one year prior of 1.6 percent. If, alternatively, central banks end 

QE or tighten too soon, the risk of deflation jumps. A passage over the "monetary cliff", the 

slippage from falling inflation or disinflation into outright deflation, would be dangerous. 1 

1 See John H. Makin, "Beware the Monetary Cliff," AEI Economic Outlook (November 2013), 

http://www.aeLorg/outlook leconomics Imonetary -policy Ifederal-reserve Ibeware-the-monetarydilIl 

11 
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86685.026

Figure 5. Year-over-Year Change in Monthly Core Consumer 

Price Indexes 

Sources: us Department of Labor, Bureau of labor Statistics; Eurastat; Organisation for Economic Co~operation and Development 

Notes: US core CPI measures Consumer Price Index for All Urban Consumers: AI! Items less Food & Energy, EU core Hlep measures 

Harmonized Index of Consumer Prices: Overall Index Excluding Energy, Food, Alcohol, and Tobacco for European Union (28 

countries). Japan core CPI measures Consumer Price Index: All Items Excluding Food and Energy for Japan, 

Deflation is self-reinforcing. As price levels fall, buyers cut spending and hold onto their cash as 

they await lower prices. Therefore, cash holdings are rewarded by deflation, and more cash 

holdings and less spending causes deflation to accelerate even further. Deflation would collapse 

asset markets as investors shift into cash and firms cut capital investment for fear of falling 

returns. 

Central banks and governments have little choice but to continue trying to navigate the narrow 

path that lies between asset inflation and dangerous bubbles and outright deflation and a 

collapse of growth, employment, and asset prices. There is no easy way to succeed. The reality is 

that the bubble-deflation dilemma means that now is a bad time to sharply alter the legislative 

mandate for central bankers. 

12 
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86685.027

The Federal Reserve and Global Central Banking 

Statement by Athanasios Orphanides before the Subcommittee on Monetary Policy and 

Trade of the Committee on Financial Services, United States House of Representatives 

Washington D.C., November 13, 2013 

I appreciate the opportunity to testify at this hearing on "What's Central about Central 

Banking? A Survey of International Models." As requested, my testimony examines 

differences and similarities of the Federal Reserve with other central banks, and in this 

respect I will focus on the European Central Bank (ECB) and the Eurosystem that comprises 

the ECB and the National Central Banks (NCBs) of the member states of the European Union 

(EU) that have adopted the euro as their common currency. 

The 100th year anniversary of the Federal Reserve is an apt occasion for reflecting on the 

structure of the institution compared to other central banks around the world. Over the 

past century, the United States has evolved into the most powerful nation on earth. In 

terms of politics, the United States has been the most potent global force for defending and 

promoting democracy. In terms of economics, the United States has been a global engine of 

innovation and growth. Historical experience suggests that a well-functioning monetary 

system is a prerequisite for the greatness of any nation, and it is hard to imagine that the 

United States could have achieved and maintained its power to the same degree, had the 

Congress not created the Federal Reserve System 100 years ago.l 

Since its founding, the Federal Reserve has evolved into the most powerful central bank of 

the world and serves a leading role in global central banking. As early as the 1920s, it was 

recognized as a pioneer in global monetary affairs. As a public institution, the Federal 

Reserve is unparalleled in the professional integrity, technical expertise, dedication to public 

service, and collegiality that has characterized its staff and leadership. But central banking 

has always been and remains an activity where knowledge is acquired by experience. 

Uncertainty is a defining characteristic of a dynamic and continuously evolving marketbased economy. Our knowledge of the workings and interrelations of the macroeconomy, 

banking and finance will never become perfect. From time to time crises materialize and 

central banks are called to deploy the power of their balance sheets to contain adverse 

consequences. The only common element in handling crises over time is insufficient 

knowledge when policy decisions have to be made. Miscalculations and misjudgments are 

unavoidable, even with the best of intentions. Room for improvement, for making the 

framework more robust, always remains. 

1 The historical significance of the founding of the Federal Reserve on the eve of the Great 

War could be put into perspective when the experience of the Government is contrasted 

with that during the War of 1812, when the United States did not have a central bank. A 

consequence of the failure to renew the charter of the First Bank of the United States (the 

nation's first central bank) in 1811 was the difficulty of the Government to meet its war 

financing needs the following year. Unlike 1812, the Government could fully utilize the 

powers of the Federal Reserve to facilitate the war effort after its founding. 
63 


86685.028

In its first 100 years, the Federal Reserve has contributed to the welfare of the nation but 

has not always managed to avoid major errors. The Great Depression of the 1930s and the 

Great Inflation of the 1970s are the most notable examples. Historians will undoubtedly 

debate for years to come the causes and handling of the most recent crisis. In my view, the 

Federal Reserve's actions in late 2008 and 2009 were decisive for averting what could have 

become an economic collapse of Great Depression dimensions. Easy money policies proved 

a potent medicine. But while some risks to monetary stability abate, other risks emerge. 

Easy money policies can prove as addictive as other potent medicines. The unprecedented 

expansion of the central bank's balance sheet and the associated continued easing of policy 

have generated new challenges. 

The institutional framework governing a central bank is a critical factor on how well it can 

preserve monetary stability and how effectively it can handle crises. The mandate of the 

institution, its decision-making structure, the appointment process of its decision-making 

bodies, the mechanisms defining its independence and accountability, all jointly influence 

the probabilities of ensuring better outcomes. In the international community, countries 

learn from others' experiences about the effectiveness of institutions, and there has been 

considerable cross-fertilization of ideas in the institutional design of central banks. 

Experience from the functioning of the Federal Reserve has influenced other central banks, 

including the European Central Bank that was established in June 1998, directly and 

indirectly. Some of the characteristics in the structure of the ECB (and more broadly the 

Eurosystem) draw on the structure of the Federal Reserve. The ECB setup also drew on the 

structure of the central bank of the Federal Republic of Germany (the Bundesbank) that in 

turn was influenced by the Federal Reserve when it was set up in the 1950s. 

I would like to draw attention to three elements of the institutional arrangements of the 

Federal Reserve System and the Eurosystem: Their decentralized nature, the independence 

of their decision-making bodies, and their mandates. 

One common characteristic of the Eurosystem and the Federal Reserve System is their 

decentralized nature and decision-making structure. This inclusiveness and incorporation of 

regional perspectives ensures that monetary policy better reflects the needs of the 

economy as a whole. The 12 regional Federal Reserve Banks in the United States have a role 

that is similar in some respects to the NCBs in the euro area, and the Board of Governors 

has similarities to the ECB. The ECB has an Executive Board with 6 members who are based 

in Frankfurt, similar to the 7 Governors of the Board of Governors based in Washington, DC. 

Monetary policy decisions for the United States are taken by the FOMC with the 

participation of members of the Board and the Presidents of the 12 district banks. For the 

euro area, such decisions are taken by the Governing Council of the ECB that comprises the 

ECB Executive Board members and the Governors of the NCBs. In both cases, the broad 

committee setup ensures regional representation and the incorporation of a rich set of 

views into policy discussions. However, the Federal Reserve is relatively more centralized. 

In the case of the ECB, the decision-making body for all matters is the Governing Council 

where NCB governors have more votes than members of the Executive Board. By contrast, 

in the case of the Federal Reserve, the Board retains a majority of votes on the FOMC and 

2 
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86685.029

has decision-making powers on its own on many matters, without representation of the 

Reserve Banks. Another important difference is that in the United States no individual state 

has control of a Reserve Bank and each Reserve Bank represents an area that covers 

mUltiple states. This ensures better integration and makes it far more likely that Reserve 

Banks will be serving the interests of the United States as a whole compared to the 

Eurosystem where the jurisdiction of each NCB coincides with the borders of an individual 

state. This limitation to integration, in the case of the Eurosystem, reflects a more 

fundamental limitation in the structure of the European Union and the euro area. In 

contrast to the United States, the European Union remains a confederation of sovereign 

states that lacks a strong common government. 

Independence from short-term political influences is one of the most important 

characteristics defining the ability of a central bank to serve a nation's best interests over 

time. Independence enables a central bank to resist short-sighted political pressures that 

invariably create inflationary biases and compromise monetary stability. Both the Federal 

Reserve and the ECB are independent central banks but with notable differences. When 

comparing the influence of the political decision-making bodies of the common currency 

area as a whole, the ECB is considerably more independent and arguably less accountable 

than the Federal Reserve. In the United States, the Federal Reserve reports to Congress and 

its powers are subject to change by law. By contrast the European Parliament has relatively 

little power over the ECB. The legal framework of the ECB is governed by the Treaties of the 

European Union and as such cannot be modified by any single government or by the 

European Parliament. With respect to the influence of individual member states, the 

relatively greater role of the NCBs in the Eurosystem, and their tight correspondence to 

individual member states, suggests a greater threat of political interference by individual 

member states in the euro area compared to the United States. 

Once appointed, decision makers are independent from governments both in Europe and in 

the United States. However, differences in the length of the term and the potential for 

reappointment suggest differences in the potential for political influence on the decisionmaking bodies. In the ECB, all members of the Executive Board, including the President and 

Vice President of the ECB, are appointed for 8-year non-renewable terms. This ensures 

maximum independence following an appointment and relatively infrequent political battles 

relating to appointments. In the case of the Federal Reserve, whereas in theory Board 

members could serve 14-year non-renewable terms, in practice this is rarely observed. 

Most members serve incomplete terms and if a member leaves before the end of a 14-year 

term, a new member is only appointed for the remainder of that term. When appointed to 

serve an incomplete term, a governor can be reappointed for a full 14-year term once the 

remainder is completed. The chair and vice chair positions also require separate 

renomination and reconfirmation after each 4-year term in those positions. This structure 

implies that most Board members, and certainly the chair and vice chair of the Board, must 

face a potentially bruising reappointment process once or multiple times to serve for several 

years. Since the prospect of reappointment may make Board members, and especially the 

chair and vice-chair, more sensitive to political influence, the independence of the Federal 

Reserve could be strengthened if all Board members were appointed for 8-year nonrenewable terms, as is the current practice for the Executive Board of the ECB. The 

independence of the Federal Reserve would also be strengthened if the remuneration of 

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86685.030

Board members were adjusted to better reflect the level of responsibility associated with 

their position. This should reduce the high turnover rates that have been observed in all 

positions other than that of the chair over recent decades. As an example, my 

understanding is that the salary of the Chairman of the Federal Reserve is less than half that 

of the President of the ECB. In my view, it does not serve the interests of the nation well to 

underpay members of the Board, especially in light of the expanded responsibilities 

envisioned for the Federal Reserve System in the aftermath of the crisis. 

Perhaps the most significant difference between the ECB and the Federal Reserve is in the 

legal text regarding their mandates. The ECB's mandate focuses on one objective, while the 

Federal Reserve's statute states multiple goals and does not offer precise guidance on their 

relative importance. The comparative lack of clarity leaves open the interpretation of its 

mandate and poses challenges for the Federal Reserve. 

Reflecting best practice following the experience with inflation and disinflation from the 

1960s to the 1980s in numerous developed economies, the mandate of the ECB, which was 

originally formulated as part of the EU Treaty in 1992, has a hierarchical nature defining 

price stability as the primary objective of the institution. Price stability is the primary 

mandate of the European System of Central Banks (ESCB) which comprises the ECB and all 

the NCBs of the EU. In contrast, the Federal Reserve has a so called "dual mandate" that 

assigns comparable importance to maximum employment. Specifically, the Federal Reserve 

should "promote effectively the goals of maximum employment, stable prices, and 

moderate long-term interest rates." 

An important reason for this difference is the timing of the adoption of the legal text. The 

current statutory mandate of the Federal Reserve reflects revisions to the Federal Reserve 

Act in 1977-78, before the crystallization of the modern consensus regarding the primacy of 

price stability as the most important contribution that a central bank can make to social 

welfare in the context of modern democracies. A historical digression can help explain the 

significance of the timing. Prior to the 1980s, rather than focus on price stability, the 

statutory mandates of numerous central banks emphasized multiple objectives including 

references to full employment as an explicit goal. As an example consider the following 

interpretation of the Federal Reserve's objectives, as stated by the Board in the first edition 

of The Federal Reserve System: Its Purposes and Functions, published in 1939: "The purpose 

of Federal Reserve functions, like that of Governmental functions in general, is the public 

good. Federal Reserve policy can not be adequately understood, therefore, merely in terms 

of how much the Federal Reserve authorities have the power to do and how much they 

have not the power to do. It must be understood in the light of its objective-which is to 

maintain monetary conditions favorable for an active and sound use of the country's 

productive facilities, full employment, and a rate of consumption reflecting widely diffused 

well-being." Although such wide-ranging interpretations of the objectives of a central bank 

may have been well-intentioned, they did not generally serve as an indicator of good 

performance. The lack of clarity also made the central bank less accountable. The painful 

experiences with inflation and disinflation from the 1960s to the 1980s highlighted that the 

demand to deliver full employment in addition to price stability overburdened central 

banks, leading to poor performance on both fronts. This led to significant change and/or 

clarification and/or reinterpretation of central bank mandates towards highlighting the 

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primacy of price stability. Characteristic of this norm has been the advent of Inflation 

Targeting (IT), a framework originally adopted by the Reserve Bank of New Zealand (RBNZ) 

in 1989. The main distinguishing characteristics of inflation targeting are the adoption of a 

numerical definition of price stability and its recognition as the primary objective of the 

central bank. As Don Brash, the Governor who first implemented IT at the RBNZ noted later, 

the multiple goals facing the central bank before the adoption of IT created conflicts that 

generated instability and inflation. "The legislation under which we operated required us, in 

formulating our advice, to have regard for the inflation rate, employment, growth, 

motherhood, and a range of other good things" (Brash, 1999). He then went on to explain 

how abandoning the multiple-goal approach and recognizing the primacy of price stability 

helped reestablish stability in New Zealand. 

The difficulty associated with too literal an interpretation of a multiple-goal mandate was 

also recognized by the Federal Reserve. Starting in 1979, under the leadership of Chairman 

Volcker, and continuing under Chairman Greenspan, the Federal Reserve effectively 

interpreted price stability as a necessary primary goal for attaining other objectives. As 

explained in the 9th edition of the Federal Reserve's Purposes and Functions, published in 

2005: "Stable prices in the long run are a precondition for maximum sustainable output 

growth and employment as well as moderate long-term interest rates." In 2004, Chairman 

Greenspan pointed to the primacy of price stability in explaining the success of Federal 

Reserve policy since 1979. As he explained, this resulted from "maximizing the probabilities 

of achieving our goals of price stability and the maximum sustainable growth that we 

associate with it" (Greenspan, 2004). 

With this interpretation of the Federal Reserve's mandate, closer comparison with that of 

the ECB suggests more similarities than differences. This is because while the mandate of 

the ECB explicitly recognizes the primacy of price stability, it does not ignore other 

objectives. To the extent feasible, the central bank could be expected to contribute to the 

attainment of other goals, but only if that did not compromise its primary objective. Thus, 

the EU Treaty specifies: "The primary objective of the ESCB shall be to maintain price 

stability. Without prejudice to that objective, it shall support the general economic policies 

in the Union in order to contribute to the achievement of the latter's objectives." And with 

regard to these objectives, the Treaty states: "The Union shall establish an internal market. 

It shall work for the sustainable development of Europe based on balanced economic 

growth and price stability, a highly competitive social market economy, aiming at full 

employment and social progress, and a high level of protection and improvement of the 

quality of the environment." Thus, full employment is one of numerous other objectives the 

ECB should support, as long as this does not compromise price stability. 

The similarity in the interpretations of the mandates of the ECB and the Federal Reserve 

that had been in place since 1979 is noteworthy, but more recent developments highlight 

that the lack of clarity in the case of the Federal Reserve comes at a cost. As part of its 

response to the crisis, the Federal Reserve has sought to improve its communications and 

provide a numerical definition of price stability. The effort to better anchor inflation 

expectations over time in this manner has been a welcome development. In light of the 

wording of its statutory mandate, however, the FOMC also introduced a numerical 

operational guide for maximum employment. Specifically, in January 2012 the FOMC 

5 
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adopted a "Statement on Longer-Run Goals and Monetary Policy Strategy," which was 

reaffirmed in January of this year. The statement defines the FOMe's understanding of 

price stability as consistent with a 2 percent inflation goal and provides numerical estimates 

of the longer-run normal rate of unemployment that the FOMC views as an operational 

guide for maximum employment, while recognizing that these estimates may change over 

time. In addition, the statement suggests that the FOMC would take a "balanced approach" 

in seeking to mitigate deviations of inflation from 2 percent and deviations of 

unemployment from its longer-run normal rate. 

With the adoption of this language, the FOMC seems to have moved away from its earlier 

interpretation that placed greater importance on the attainment of price stability. While 

the new language is closer to a literal interpretation of the Federal Reserve's statutory 

mandate, it engenders the same risks faced by the Federal Reserve before 1979, the earlier 

period in its history when a similar literal interpretation of multiple goals with elevated 

attention to maximum employment was in effect. 

In light of the earlier historical experience, the risks of overburdening the Federal Reserve 

with mUltiple conflicting goals should be well known. The tensions associated with an overly 

literal interpretation of the Federal Reserve's mandate were also highlighted in a recent 

speech by Chairman Volcker: "I know that it is fashionable to talk about a 'dual mandate' -

that policy should be directed toward the two objectives of price stability and full 

employment .... Asked to do too much ... [the Federal Reserve] will inevitably fall short. If in 

the process of trying it loses sight of its basic responsibility for price stability, a matter which 

is within its range of influence, then those other goals will be beyond reach" (Volcker, 2013). 

These risks, which are caused by the lack of clarity of the statutory mandate of the Federal 

Reserve, could be mitigated by Congress. A clarification explicitly recognizing the primacy 

of price stability as an operational goal for the FOMC would be the best defense of 

monetary stability over time. Subject to maintaining price stability, the Federal Reserve 

could be instructed to contribute as possible to other objectives, including maximum 

employment, similar to current practice in Europe. In addition, and in light of the greater 

authority the Federal Reserve has gained over banking and financial regulation, financial 

stability should be more clearly highlighted in the mandate. 

References 

Brash, Donald (1999j. "Inflation targeting: an alternative way of achieving price stability," 

address on the occasion of the 50th Anniversary of Central Banking in the Philippines, 

Manila, 5 January. 

Greenspan, Alan (2004). "Risk and uncertainty in monetary policy," American Economic 

Review, 94(2), 33-40. 

Volcker, Paul (2013). "Central Banking at a Crossroad," remarks at the Economic Club of 

New York, May 29. 

6 
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Testimony before the House Financial Services Committee 

Subcommittee on Monetary Policy and Trade 

Hearing entitled "What Is Central About Central Banking?: 

A Study of International Models" 

Adam S. Posen 1 

November 13, 2013 

Chairman Campbell, Ranking Member Clay, and Members of the 

Committee, thank you for the opportunity to testify in this hearing. It is a 

privilege for me to contribute to your discussions of what is central to central 

banking, when you rightly take stock of the Federal Reserve's performance and 

governance after 100 years of operation, and after five years of its policy 

responses to the North Atlantic financial crisis centered here in the US. As 

someone who has been studying differences in central banks' structures and 

performance for twenty years, and has worked in a number of the major central 

banks as an economist, consultant, and policymaker, I commend your taking a 

comparative international approach to benchmarking the Fed's performance 

and role. 

I would like to address two sets of issues regarding the operational 

structure of central banks in my testimony. All of these have a significant 

influence on the ability of central banks operating in democracies with market 

economies to fulfill their public mission. All of these show some significant 

1 Adam Posen is President of the Peterson Institute for International Economics (contact 

posena@piie.com). The views expressed here are solely his own, and do not necessarily 

represent the views of the Institute or of any other member of its staff or Board of Directors. 

1 
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variation among the major central banks in critical aspects of their capabilities 

and practices. And some of these represent areas where the Federal Reserve 

System, and the relationship between the Fed and Congressional oversight, 

could benefit from improvement. 

• Governance of the central bank and setting of its policy goals 

• Tools available to the central bank for policy implementation 

As my colleagues, Messrs. Lachman, Makin, and Orphanides, have 

argued in their written testimony submitted for this hearing, and as your 

Committee staff has documented, the major central banks in democratic 

countries hit by the financial crisis - the Fed, European Central Bank [ECB], 

Bank of England [BoE], Bank of Japan [BoJ], Swiss National Bank [SNB], and 

others have responded along largely the same lines: cutting instrument 

interest rates to near zero, expanding their balance sheets by buying securities, 

aggressively intervening to counteract market disruptions during the height of 

the crisis, and maintaining an easy stance of monetary policy (to varying 

degrees) through the present. 

The economies and publics they serve have seen largely the same results 

on the broad macroeconomic aggregates: very low inflation with little 

inflationary pressure, some improvement in growth and employment but far 

from total recovery, little market pressure on longer-term government debt 

securities, and relatively stable currencies after some discrete one-time 

adjustments. I believe this is the result of these central banks getting policy 

more or less right, but being insufficiently aggressive about stimulus in some 

cases, and being outweighed by fiscal and banking developments overall. 

Still, below the top line similarities of policy and performance from mid2008 to present, there are some important differences between the Fed and its 

peer central banks in outcomes. More importantly, I would argue, there are 

divergences and vulnerabilities between central bank practices that are 

becoming highly salient as we get further from the overt crisis and turn to the 

2 
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more contentious issues of when and how to tighten monetary policy, providing 

financial stability, and handling the feedback from the policies already pursued 

upon our own and other economies. 

Chairman Bernanke and the FOMC are to be praised for their crisis 

response which saved the American people from terrible economic outcomes, 

what would have been far worse than what we actually suffered - good 

leadership and management in a crisis is never a foregone conclusion. But in a 

sense, during a financial crisis the right direction for monetary policy is clear, 

and the central bank's choice of tools is simply to use everything you got fast. 

The FOMC and the members of this Committee should now be thinking ahead 

about how to prepare our central bank for future policy challenges when there 

will be more room for genuine debate about the right direction of policy and the 

right methods with which to pursue that policy goal. 

1. Governance of central bank goal setting -

Accountability is a two-way street. The Federal Reserve must be 

overseen by elected officials, as it currently is, and as all central banks should 

be. But the form and nature of that oversight must allow for the central bank 

to make policy without undue political pressure or arbitrary interference. The 

best practice for making such oversight work is to distinguish between goal 

and instrument independence for central banks - central banks should have 

instrument independence, but not goal independence.2 

That is, the elected officials set the goal of policy, usually called the 

central bank's mandate, and the technocratic leaders and staff of the central 

bank are left to pursue those goals by the means and measures they think 

best. Of course, the central bankers in the US, the FOMC members - have to 

be held accountable for their performance in meeting those objectives, but that 

2 As defined by Stanley Fischer in 1994. See: Debelle, Guy and Stanley Fischer. 1994. How 

Independent Should a Central Bank Be? In J.C. Fuhrer (ed.), Goals, Guidelines and Constraints 

Facing Monetary Policymakers. Federal Reserve Bank of Boston, 195-221. 

3 
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should be done retrospectively, based on a few years' policies and outcomes at 

a time. Monetary policy decisions cannot be fully evaluated in real time, given 

the lags between when policy is set and the full effects are seen. That is part of 

what makes it so challenging for both central banks and elected legislators. 

Perhaps this sounds self-evident. But international experience shows 

that this distinction matters greatly. Where central banks have too much goal 

independence, bad things happen. In Japan, throughout the 1990s and most 

of the 2000s, the BoJ Policy Board was allowed to define price stability as it 

saw fit, and allowed the economy to enter an extended period of deflation. 

Worse, the BoJ eluded accountability for its policy failures for much of the 

period, and publicly blamed deflation and terrible economic outcomes on 

everything but monetary policy without sustained political challenge. In the 

euro area, the ECB has to some degree run amok, ignoring its mandate to 

achieve price stability of near 2% inflation, ignoring its obligation to pay 

attention to broad credit growth, and ignoring wide divergences in monetary 

outcomes across the whole of the European Monetary Union. Instead, it has 

entered into the budget politics of sovereign member states and even their 

regulations of non-financial sectors like labor markets and tax policy. 

As I warned in 1993, when the ECB structure was first proposed, having 

an unaccountable central bank with no parliament above it, its independence 

protected by essentially inviolable international treaty, was a recipe for 

excessively and destructive counter-inflationary extremism. 3 This is indeed 

what has happened in response to the crisis, though the ECB has moderated 

somewhat in the last 18 months. In contrast, in the United Kingdom and 

Switzerland, where the BoE and SNB are very much goal dependent and 

answerable to elected officials, there were salutary corrections to the 

3 See Adam S. Posen, "Why Central Bank Independence Does Not Cause Low Inflation: There is 

no institutional fix for politics," in Richard O'Brien, ed., Finance and the International Economy: 

7, Oxford University Press, 1993. 

4 
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operational goal of monetary policy in response to crisis developments, to allow 

for specified areas of flexibility and minimum standards in other areas - more 

response to real volatility and to slow growth for the BoE, more concern with 

the exchange rate in opposition to deflation for the SNB.4 Earlier this year, the 

new Japanese government did finally hold the BoJ accountable for its failure to 

deliver on a reasonable operation definition of price stability, meaning its 

insufficient effort and responsibility to fight deflation. The BoJ has changed 

policies to meet its clearly and legitimately set goal, and has delivered good 

results. 

Do the Congress and the Fed have it right on goal dependence versus 

instrument dependence? Certainly more so than the ECB, but the relationship 

is not perfect. As we have recently established in some new research, having 

elected officials set and reset central bank goals in a transparent manner has 

minimal effect on inflation outcomes, and even on the anchoring of inflation 

expectations (i.e., how much inflation drifts upwards when there is a cost 

shock or a monetary accommodation).5 Central bank independence is not 

fragile to even robust oversight of goals. 

Yet, there is much hubbub in the Congress and among some 

commentators when the Fed adjusts its targets in response to the crisis in a 

transparent way and in consultation with Congressional oversight that 

independence is being compromised. This is wrong. So, too, however, is the 

reluctance of Fed officials to let Congress discuss directly the definition of 

goals, engendered by the justified fear that any re-opening of the Federal 

Reserve Act could be a Pandora's Box. We need a process by which the Fed's 

4 See my testimony to the Joint Economic Committee on Apri118, 2013, 

http://www.piie.com/publications/testimony/posen20130418.pdf, and the recent speech by 

the SNB Chairman Thomas Jordan on October 8,2013, 

http://www.piie.com/publications/papers/jordan20 131008ppt.pdf. 

5 See Kenneth Kuttner and Adam Posen, "Goal Independence for Central Banks: Is the malign 

view correct?", November 7, 2013, 

http://www.imf.org/ external/np/res/ seminars/2013 /arc./pdf/posen.pdf 

5 
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operationalization of its current Dual Mandate can be reviewed and debated by 

Congress without the threat of massive institutional change or politicization. 

This was one of the reasons why the current Fed Chairman with co-authors 

(including myself) advocated an inflation targeting framework for US monetary 

policy explicitly in a framework of Congress setting the inflation target. 6 There 

are other options, but we need a decent process for so re-setting. 

The real issue, however, is the extreme distrust which many members of 

Congress are showing towards the instrument independence of the Fed. The 

extreme form is the absurd conspiracy theory that seems to be behind the idea 

of "auditing" the Fed, that somehow there are purchases and sales of Fed 

assets that have taken place without public knowledge or oversight. This is 

demonstrably false. The Fed's balance sheet and market operations are more 

transparent than their or any other central banks' have ever been (some issues 

over disclosure of specific bank names in crisis bailouts aside). But there are 

three far more operationally significant areas where excessive Congressional 

distrust harmfully interferes with instrument independence: 

• Minutes - No other central bank is required to produce literal transcript 

minutes of such detail at such frequency as Congress requires of the 

FOMC. This has a chilling effect on the willingness of FOMC members to 

speak on the record, openly debate policies, and to advance ideas and 

positions that may later be proven wrong (even if useful to discussion). 

This distorts internal and side meetings of FOMC members as well, and 

conveys no useful information except for 'a-ha gotcha' purposes beyond 

what more edited depersonalized minutes as the BoE, ECB, and others 

produce. This also makes FOMC members less accountable for their 

individual votes and opinions. Congress should revised this 

requirement. 

6 Bernanke, Ben, et ai, Inflation Targeting: Lessons from the International Experience, Princeton University Press, 

1999. 

6 
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• Capital - On paper, all central banks have an amount of capital on their 

balance sheets that is at the basis of their operations. In financial and 

economic terms, this is a meaningless line-item not a real constraint -

the central bank can always print money and engage in operations, and 

so long as the elected officials have the central bank's back, the capital 

can be replenished if temporarily eroded for some reason. But politically, 

this becomes a huge source of threat to hold over monetary policymaking 

if it can be used to express dissatisfaction with what means a central 

bank is using to pursue its mandated goals. This has led to bad selfcensoring in the ECB case. In Japan, the BoJ used this as an excuse for 

inaction. Here in the US, arguably the FOMC is making decisions about 

how to handle the assets on its balance sheet with an eye as to avoid 

attracting Congressional opprobrium rather than pursuing the best use 

of the assets as tools. I would argue that the Fed should be thinking 

about selling off bonds when it is time to tighten policy, but many would 

have the Fed hold on to them to maturity simply to avoid registering a 

paper loss Congress might use as a club. Congress should give the Fed 

in advance an indemnity against losses on its balance sheet incurring in 

its monetary operations so long as they are in pursuit of mandated goals 

(which they would be), as the BoE has from HM Treasury.7 

• Specific constraints on Fed purchases - While setting goals and 

evaluating the competence of pursuit of those goals is rightly Congress' 

role with respect to the Fed, judging what are the appropriate means to 

achieve those goals a priori is not. The Congress, despite its best efforts 

and strong staff, is not qualified to make that technical evaluation of 

what the Fed can buy and sell; no one, even experts, can really make 

7 See my discussion of this issue in a speech from my time on the BoE Monetary Policy 

Committee, June 11,2012: http://www.telegraph.co.uk/finance/economics/9324650/AdamPosens-speech-in-full.html 

7 
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86685.040

that evaluation except ex post, and as a judgment dependent upon the 

economic context in which the purchases and sales are made; and it is 

inherently a politicization of monetary policy decisions that would be 

harmful to price stability to have elected officials getting involved in 

granting and withholding operational options to the Fed. No other major 

central bank - not the ECB, BoE, BoJ, SNB, or any others - in a 

democracy has the kind of constraints on its balance sheet operations 

that Congress has increasingly imposed on the Fed. Had these 

constraints been in place during 2008-09, we would have had a disaster 

when other central banks flexibly and aggressively responded to financial 

crisis. In fact, the ECB actually led the way in so doing and was initially 

ahead of the Fed in crisis response because of reluctance on the Fed's 

part due to worries about attracting congressional interference. The 

Congress should respect the Fed's instrument independence, and only 

evaluate what tools or assets the Fed uses retrospectively as part of the 

overall competence accountability. 

2. Tools for the pursuit of financial and price stabilitySince the Congress is at present deeply involved in setting limits on the 

Fed's tools in pursuit of its mandated goals, and since the long-term structure 

and performance of the Fed is certainly within Congress' legitimate purview, let 

me now address the issue of what tools the Fed does or does not have in 

comparison with other central banks. The place to start is with the operational 

- as opposed to the independence - aspects of the current limits on Federal 

Reserve asset purchases. These are truly exceptional, and are likely to be 

extremely harmful to the pursuit of financial stability by the Fed. 

Public debate has also been allowed for too long to stigmatize 

"unconventional" monetary policy, and wax nostalgic for the days of a simpler 

Fed mission. The Fed has, perhaps understandably, let this happen for fear of 

provoking further political interference. But such defensiveness and self8 
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limitation is based on a mischaracterization of the past and creates a 

dangerous vulnerability for the US economy. For literally centuries, central 

banks have bought and sold private sector assets as a necessary part of their 

operations. There was a brief interlude, from the late 1970s through the mid 

2000s when it looked like the Fed and other rich country central banks could 

implement monetary policy and maintain financial stability solely by purchases 

and sales of the short-end of the government bond market. To a large and 

increasingly evident degree, the extent to which this reliably worked versus the 

was always overestimated, was based on a theoretical fiction about how 

interest rates affected the real economy, and was simply politically convenient 

because it pretended Fed policies did not have an impact on income and wealth 

distribution.s 

Congress will have to make it possible for the FOMC to treat so-called 

unconventional monetary policy as conventional, and establish a viable 

oversight framework for doing so. The great lesson of the global financial crisis 

for monetary policy is that there is no one interest rate that determines or even 

represents credit conditions in the modern economy. Recent events show the 

more complex reality of how monetary policy is transmitted to the whole 

economy, as opposed to just bond markets. In the euro area, low interest rates 

and commitments to government bond market intervention are failing to 

improve credit conditions for small and medium-sized businesses across 

southern Europe. The BoJ has only been able to successfully reverse deflation 

by changing the mix of assets it purchases to longer-maturity and some private 

assets; when it solely bought short-duration JOBs, its quantitative easing was 

ineffective. 9 In China, Hong Kong, and Turkey, attempts to constrain property 

lending booms have required targeted measures as well as rate rises. Right 

8 See my discussion of the distributional issues of monetary policy in Adam Posen, "After 

Bernanke, Make Unconventional Policy the Norm," Financial Times, July 15, 2013. 

http://www.piie.com/pu blicationsl opeds / oped.crm ?ResearchID=2442 

9 See my discussion of Japanese monetary policy pre-2013 in Adam Posen, "The Realities and 

Relevance of Japan's Great Recession: Neither Ran nor Rashomon," June 2010, 

http://www.piie.com/pu blications / interstitial.crm ?ResearchID= 1592 

9 
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now, the BoE is allowing the blowing of another housing price bubble by not 

intervening directly to offset mistaken government policies. 

In the United States, the Fed's purchases of mortgage-backed securities 

have done more to promote the current private housing-led economic recovery 

than buying long-dated Treasuries alone could ever have done. It is sheer luck 

that purchases of mortgage-backed securities were still allowed by Congress 

and that happened to be the right thing to buy to deal with the US mortgagecentered debt crisis. If the next crisis comes in American money market mutual 

funds or local banks' capital, the US economy may not be so fortunate because 

the Fed will not be able to intervene effectively. 

To repeat, no other major central bank is constrained in this way that 

Congress has constrained the Federal Reserve - if anything, the right lesson of 

the crisis is that central banks have to be ready to intervene across a wide 

range of asset markets and deal with mUltiple credit markets. That is why all 

other major central banks have at least as much flexibility with regard to tools 

as before the crisis, if not having been granted additional capabilities. 

Congress has taken the Fed in exactly the wrong direction. 

Worries about losses on risky assets are nothing but a distraction. The 

purpose of Fed market operations is to deal with major macroeconomic shocks 

and trends that have huge impact on the economic well-being of all Americans. 

Whether the Fed temporarily loses money on a small part of its portfolio or 

temporarily distorts a hypothetical pure market outcome for a particular asset 

class in service of that greater good should not be a constraint on doing the 

right thing. Yet, some in Congress are fixated on these potential paper losses 

and that fixation translates into both legislative interference and the FOMC 

pre-emptively ruling out policy options and instrument it should actively 

consider solely for political fears. And of course, the cumulative gains that the 

Fed has transferred to the US Treasury over the decades outweigh by two 

10 
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orders of magnitude any potential losses on the Fed's balance sheet in a given 

set of operations. And we would not want the Fed to have justified let alone 

pursued the QE policies it did just for the sake of showing a profit! 

My final point is to warn the members of this Subcommittee of letting 

further counter-productive constraints on the Fed's range of policy options 

creep in through a particular back door. As this is the Monetary Policy and 

Trade Subcommittee, you are no doubt aware of some initiatives to make 

strictures against currency manipulation requirements for some trade pacts 

such as TPP currently under negotiation by the US, or as a pre-requisite for 

granting Trade Promotion Authority to the Administration to negotiate those 

pacts. I will leave aside that debate in general terms today. I will, however, say 

that it would be the ultimate usurpation of the Fed's necessary instrument 

independence, and even more so of Congress' legitimate oversight of the goals 

for US monetary policy, were such a trade condition to be used against the 

Fed's own choice of instruments. 

Yet, that is a concrete and significant danger if such trade requirements 

were to be poorly or too broadly drafted in the legislation. Countries would 

unfairly and harmfully insist that Federal Reserve monetary policy - necessary 

to the well-being of the US economy - would have to be limited or even reversed 

if it could be construed as 'currency manipulation.' They would be pursuing 

their own mercantilist self-interest at huge macroeconomic cost to the US 

economy. Thus, any such legislative language much be clearly linked to 

explicit acts of currency manipUlation, involving the one-sided sustained 

intervention by purchasing with official reserves by countries already in 

substantial trade surplus. It must not be allowed to treat expansionary 

monetary policy directed at domestic goals to be constrained from the outside. 

Thank you for your attention. 

11 
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Bell's Praet: Negative Deposit Rate, Asset Purchases Are Options ~ ... http://online.wsj.com/news/articles/SB 1 000 1424052702304243904 ... 

lof3 

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EUROPE NEWS 

ECB's Praet: All Options on Table 

Central Bank Could Adopt Negative Deposit Rate, Asset Purchases If Needed 

By BR!AN BLACKSTONE 

Updated Nov. 13,20132:13 p.m. ET 

FRANKFURT-The European Central Bank could adopt negative interest rates or purchase assets from 

banks if needed to lift inflation closer to its target, a top ECB official said, rebutting concerns that the 

centra! bank is running out of tools or is unwilling to use them. 

Peter Praet in Washington, D.C., on Oct. 11. 

Bloomberg News 

More 

Europe's Central Banks Take Different 

Paths as Economies Diverge 

Euro Recovers, but Possible Easing Casts 

Shadow 

Four Takeaways 

"If our mandate is at risk we are going to take all the 

measures that we think we should take to fulfill that mandate. 

Thatts a very clear signal," ECB executive board member 

Peter Praet said in an interview Tuesday with The Wall Street 

Journal. 

Annual inflation in the euro zone slowed to 0.7% in October, 

far below the central bank's target of just below 2% over the 

medium term. The euro dipped briefty after the comments 

appeared on the Journal's website. 

Mr. Praet didn't rule out what some analysts see as the 

strongest, and most controversial, option: purchases of 

assets from banks to reduce borrowing costs in the private 

sector. 

"The balance-sheet capacity of the central bank can also be 

used," said Mr. Praet, whose views carry added weight as he 

also heads the EC8's powerful economics division. "This 

includes outright purchases that any central bank can do." 

Additional stimulus from the ECB isn't needed right now, Mr. 

Praet Signaled, noting that inflation risks for the euro zone as 

a whole are balanced after last week's unexpected ECB 

interest-rate cut. 

On Thursday the central bank reduced its key lending rate to 

0.25%, a record low. 

The move came days after the October inflation report 

fanned fears that the euro zone may slip into a period of 

11125!2013 1:37 PM 
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ECB's Praet: Negative Deposit Rate, Asset Purchases Are Options *." http://online.wsj.com/news/articles/SB I 000 1424052702304243904 ... 

20f3 

excessively low inflation or, in some places, persistent declines in consumer prices, known as deflation. 

This cripples economic activity by holding wages and profits down and hampering efforts by the private 

sector and governments to reduce debt. 

Some of the countries hit hardest by the eura zone's debt crisis, including Ireland, Greece, Cyprus and 

Spain, have inflation rates of zero or lower. 

The ECB could do more if necessary, Mr. Praet said. "On standard measures, interest rates, we still have 

room and that would also include the deposit facility," he said. 

The central bank's deposit rate has been set at zero for several months. Making it negative would 

effectively levy a fee on commercial banks that park funds at the ECB. 

That would be aimed at spurring bank lending to the private sector, which would boost growth and 

inflation. However, a negative deposit rate would also weigh on bank profits. 

STREAM 

Europe's Debt Crisis 

GO TO FULL STREAM» 

Another option is to make more cash available to financla! 

institutions, as it has in the past with cheap, long-term loans, 

known as LTROs, Me Praet said. 

The ECB has so far resisted large-scale asset purchases as 

a means to boost growth. 

The Federal Reserve and Bank of Japan have used this tool, 

known as quantitative easing, aggressively to spur lending 

and keep inflation from falling too low, buying large swaths of 

government and private debt 

The ECB purchased safe bank and government bonds at the 

height of the global financial crisis and Europe's 

sovereign-debt crisis, but in small amounts compared with 

other major centra! banks, 

Such bond purchases are deeply unpopular in Germany, 

where long-standing fears of inflation inspire doubts about 

easy-money policies. 

Jens Weidmann, who heads the German central bank as well as serving on the ECB's Governing Council, 

opposed the ECB's decision last year to create a program to buy government bonds. Nevertheless, the 

program, which hasn't even been used, has been widely credited with helping calm the bloc's debt crisis, 

The EC8's charter forbids it from financing governments, and Mr. Praet said the bank must respect such 

lega! constraints. However the rules "do not exclude that you intervene in the markets outright," he said. 

Mr. Weidmann was also in the minority of ECB officials who opposed last week's rate reduction, preferring 

to wait for more information on the inflation outlook. This has led to some concern that jf the ECB can't 

unanimously agree on a cut to its key lending rate, reaching consensus on more outside-the-box monetary 

pOlicies will prove tricky. 

"For some decisions it's easier than others" to gain consensus, Mr. Praet said, "One thing is clear: the 

Governing Council has been able to decide. That's really the message." 

The need for more aggressive stimulus is increasingly being debated by economists and investors. 

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30f3 

Economists at BNP Paribas argue the ECB should buy €50 billion ($67 billion) per month of government 

bonds of euro-zone countries and start doing so "the sooner the beUer." Still the French bank places the 

odds of that happening at under 50·50, "probably by a wide margin," in part because of likely resistance 

from the ECB's conservative wing. 

Mr. Praet rejected fears, particularly in Germany, that low ECa interest rates harm savers by reducing the 

interest rate they earn on depOSits. Low interest rates tend to favor borrowers over savers. 

"Creditors and debtors always have an interest in a stable anchor, which is price stability in the medium 

term," Mr. Praet said. "The action to reduce uncertainty is good for the climate for savers." 

The comments sent the euro tumbling to a session low of $1.3391, from $1.3455, just minutes after they 

appeared on the Journal's newswire and website. The currency later raWed to trade at $1.3447, from 

$1<3435 late Tuesday< 

The eura losses were held in check, as many investors believe the ECB will not make a sudden shift to 

negative deposit rates, electing instead to stimulate the economy through less-dramatic steps, such as 

lowering its main refinancing rate below 0.25% or cutting minimum reserve requirements for banks. 

-Todd Buell, Christopher Lawton and Ira !osebashvili contributed to this article. 

Write to Brian Blackstone at brian.b!ackstone@wsi.com 

Copyright 2013 Dow .k:mes & Company, Inc. All Rights Reserved 

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11/25/2013 1:37 PM 
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International Central 

Banking Practices 

Testimony Before the House Subcommittee 

on Monetary Policy and Trade 

Lawrence Lindsey 

11/13/2013 

Originally Submitted 10/10/2013 
83 


86685.048

Mr. Chairman, members of the Committee, I am honored to be here today to discuss 

international central banking practices and to compare and contrast how different countries 

handle the issues attendant to monetary policy. The five areas that I am going to focus on are (I) 

political independence; (2) its corollary, accountability; (3) the objective of the central bank, 

often called its "mandate"; (4) how these objectives are communicated; and (5) the tools that are 

used to implement policies designed to attain these objectives. While many emerging markets 

such as India, Mexico, South Africa, Indonesia and Brazil have central banking practices that 

warrant attention, my remarks are going to focus on the four main developed central banks: the 

Fed, the European Central Bank (ECB), the Bank of Japan (BoJ) and the Bank of England 

(BoE). In addition my remarks will contain references to the central banks of Canada and 

Australia. 

Before looking at these areas to compare and contrast practices, it is worth looking at 

some similarities about central banking practices that often get lost in such discussions. These 

similarities comprise the metaphorical forest that often gets lost when we get preoccupied with a 

discussion of the trees. And by ignoring the forest we are often skewing the discussion in ways 

that can be less than helpful. 

First, for all the talk about "mandates" single and dual, inflation and employment, ALL 

central banks have an unspoken mandate that, using a Star Trek phrase, I would call the prime 

directive. All central banks have primary responsibility for maintaining the stability of the 

financial system, and doing so in three areas: (I) the banking system; (2) asset prices more 

generally; and (3) the government's fiscal sector. This three part prime-directive is the sine qua 

non of central bank behavior since without stability in the financial system targeting inflation and 

unemployment or some combination thereof becomes impossible. 
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This reality became obvious in the recent financial crisis as virtually all central banks 

seriously pushed the envelope with regard to their so-called "mandates" in order to keep the 

financial system functioning. Every central bank engaged in extraordinary measures in order to 

keep the system afloat, and some of these extraordinary measures went beyond the traditional 

mandates. The most obvious case of this was the Bank of England which was forced several 

times to write the obligatory letter explaining why it had exceeded its mandated inflation target 

but was still pursuing an aggressively easy monetary policy. 

In Europe the ECB is prohibited from monetary financing of the deficits of the nation 

states. But it was obvious that the financial stability of several key government bond markets 

was at risk. The ECB handled this with a number of programs. The Securities Market Program 

(SMP) was nominally designed to improve the monetary transmission mechanism. The L TRO 

program provided indirect lending by allowing banks to deposit long term government bonds at 

the ECB as collateral for which they got long term funding in return. And when it comes to asset 

price maintenance, the Bank of Japan has directly purchased both REITs (Real Estate Investment 

Trusts) and equity market index funds. The Fed tried, and abandoned, a similar facility through 

the T ALP program. 

The second great "forest" that is missed by focusing on the "trees" is that the distinction 

that is often made between the balance sheets of the sovereign government and the balance sheet 

of the central bank is merely a useful fiction. In reality, the taxing authority of the government is 

the backstop of the balance sheet of the central bank and the money issuing authority of the 

central bank allows the guaranteed redemption at face value of the government's debt. This fact 

has two important implications, one for fiscal policy the other for monetary policy. 
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The implication for fiscal policy is that a long term credible fiscal policy is a prerequisite 

for an effective monetary policy. If the government's balance sheet becomes unsustainable, then 

its ability to use its taxing authority to support the balance sheet of the central bank becomes 

untenable. How might this happen? Suppose the central bank takes on a lot of government debt 

onto its balance sheet and due to a change in sentiment yields start to rise. The central bank 

balance sheet quickly goes underwater since its bond holdings are now worth less than par. It 

might not recognize these losses formally, but markets might. The central bank might say that it 

is holding its long term bonds to maturity, but what if the ultimate redemption of that long dated 

maturity is not considered credible because the long term fiscal position of the government is 

unsustainable? The central bank then loses its ability to issue its paper since its balance sheet is 

both underwater currently and will never become solvent. That is the end of the central bank as 

it was under Weimar, for example. 

This fact is why the Bank of Japan was insistent that the government stick with its plans 

to implement the Consumption Tax hike that had been passed by the previous government. This 

is why the European Central Bank always talks about "conditionality" when it discusses 

programs that link monetary policy to the purchase of debt issued by member governments. It is 

why the Chancellor of the Exchequer in Britain is careful to keep British deficits on a downward 

trajectory; it allows the Bank of England to continue to purchase gilts. By extension I would 

argue, the long term path out of the Fed's current balance sheet position is fiscal consolidation 

and the long term shrinkage of the unfunded liabilities in our entitlement programs. If this does 

not happen it will be very difficult for the Fed to engineer a painless exit from Quantitative 

Easing. 
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The monetary policy lesson from the effective unity of the central bank and government 

balance sheets is that Quantitative Easing is lowering the effective duration of government debt 

at a time when one might imagine government should be mimicking private sector borrowers and 

trying to lengthen its duration. Of course the very purpose of Quantitative Easing programs in 

all of their international guises is to flatten the yield curve. To do this in a yield-curve-bullish 

way, the central bank must shorten the effective duration of government debt while pegging the 

short end of the yield curve. Of course, the effect of this is to push the private sector into other 

risky assets, drive up their price, and hopefully create a wealth effect that will lead to higher 

levels of current consumption and investment than would otherwise have occurred. 

But note that this is not a reduction in financial risk it is merely its deferral. The 

financial position of the private sector is intentionally being made more risky - that is the point 

of the exercise after all, to bid up the prices of risky assets. But the long term financial position 

of the public sector is also being made more risky as its net reliance on short term funding also 

increases. Some have argued that the central bank is a "patient" holder of government securities, 

and so it is. So is the Social Security Trust fund. But while transferring government debt to 

either a central bank or a different subsidiary of the government like a trust fund may reduce the 

riskincss of the "on budget" balance sheet, it does nothing to reduce the overall riskiness of the 

entire balance sheet. In fact a hallmark of many financial crises - be it public sector ones like the 

Asian financial crises of the 1990s or the private sector one of five years ago when institutions 

were too reliant on short term wholesale funding is an excessive reliance on short term 

funding. 

This brings us to the third lesson of the "forest" wide view of central banking - its 

relative independence from the political world. All countries have found it useful to have at least 
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some degree of separation between the government of the moment and the central bank. In 

practice the degree of independence varies with the personalities involved regardless of what the 

formal arrangements may be. But one other reality that stems from the issues discussed here -

like co-dependence of balance sheets and the ultimate responsibility for financial stability - is 

that central banks can never be truly separate or independent from their sovereign governments. 

A somewhat cynical way of expressing this is that governments allow central banks 

independence over those matters about which they the government really don't want to have 

responsibility. One anecdote about this is that Arthur Burns was having lunch with Wright 

Patman, then Chairman of the Banking Committee and a man known for his attacks on the Fed. 

When Burns asked Patman why given those views he never let any anti-Fed legislation out of 

Committee the Congressman reportedly replied, "if we didn't have you to blame what would we 

do?" 

It is useful to bear in mind that when political figures call for some curtailing of the 

freedom of movement of the central bank that they are implicitly placing more responsibility on 

themselves for the conduct of that policy. Whether or not the political institutions effectively 

pick up that responsibility and wield it in an effective way is often left an open question. My 

conclusion from this view of the "forest" is that elected governments might do well to let central 

banks exercise considerable latitude but then hold them accountable through hearings for 

maintaining a logical and coherent set of policies. Limitations on central bank actions, while 

well intended, often create a vacuum in responsibility that is difficult to fill by political 

authorities when the time to do so is most needed. Having examined the "forest", let me now 

turn to the "trees". 

Political Independence 
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Central banks differ quite a bit in the formal degree of political independence they are 

granted and in how that independence is protected structurally. For example, in three AngloSaxon countries: the United Kingdom, Australia, and Canada, the decision of the central bank 

can be formally overridden by the government. In the United Kingdom the Chancellor can give 

explicit orders to the central bank under "extreme circumstances" which must then be 

subsequently ratified by the Parliament. (Due to the nature of Cabinet government in the UK 

this should be considered a formality or the government would fall.) In Australia the policy of 

the central bank can be overruled by the Treasury and the bank can then be required to change it. 

In Canada, the Minister of Finance, with authorization from the Cabinet, can issue a written 

directive to the Governor of the central bank specifying a change in policy. Although these rules 

would be considered as depriving the central bank of its independence in the American context, 

in practice these measures are never used. As noted above, if the government were to issue an 

explicit order to the central bank, it would then become responsible for the consequences of that 

order, and governments tend to be loathe to take such responsibility on themselves. 

At the other extreme lies the European Central Bank which has independence not only 

formally guaranteed by the treaty that created it, but has the advantage of not having a strong or 

unified central government to. report to. This latter fact leads to a very independent governing 

structure. The Chairman is appointed for one single eight year term by agreement by all 

Eurozone countries. In practice this has meant that the candidate must be acceptable to Germany 

and France. Having no reappointment means that there is no incentive for the Chairman to try 

and please anyone. In addition there are five members of the Executive Board with staggered 8 

year terms and the heads of the central banks of each of the countries that is a member of the 

Eurozone. This latter group assures that no single political group can dominate the board. (1 
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might note that this has its echoes in the membership of the FOMC which includes the 12 

regional bank Presidents who are accountable to independent boards of directors.) 

In between lies the Bank of Japan with a governor, two deputy governors, and six 

executive directors appointed by the Cabinet on a staggered basis. This does not create any 

solid institutional basis for independence from the Cabinet. Moreover the law mandates that the 

BoJ "maintain close contact with government and exchange views". Despite this the BoJ 

exercises an enormous amount of independence. This became apparent in January when 

outgoing BoJ Governor Shirakawa negotiated a letter of understanding with the incoming Abe 

government on monetary policy. The Abe government had just been elected with the largest 

majority in the history of modern Japan and had run on a platform that included changes to 

monetary policy. Shirakawa was a lame duck whose term was about to expire. Still, that 

agreement was not one sided, a tribute not just to Shirakawa but most importantly to the real 

independence of the Bank of Japan. 

[n my opinion the BoJ holds its independence due to the enormous respect it possesses in 

Japanese public opinion. At one point the idea was even floated that BoJ issue its own debt 

rather than the government. That makes no particular sense given the co-dependence of 

governments and central banks and the unity of their balance sheet, but it was an indication that 

the Bank holds greater respect than the Ministry of Finance. One reason for this might be that 

the BoJ has been a permanent fixture in Japan, with a tradition that long predates the second 

World War. By contrast, governments in Japan turnover very frequently and have tended to be 

special interest oriented. So, the real independence of the BoJ is one that has been earned in the 

court of public opinion, rather than formally granted by the government. 
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This leads to an impottant conclusion about the nature of independence. In the end, just 

as nothing succeeds like success, nothing guarantees a central bank's independence more than 

the quality of its performance as perceived by the public and the markets. Regardless of formal 

structure, the true independence of the central bank will vary with the quality of the men and 

women who serve there. Nominate people to serve on the governing boards of the central bank 

who are perceived as independence. With such individuals in office it really doesn't matter how 

much consultation occurs between the central bank and the government. 

Accountability 

With formal fixed terms for governors and members of the central banks' governing 

bodies, it is hard to insure accountability in any formal sense. The standard recipe for such 

accountability is public hearings. There are two a year for the Fed before each House of 

Congress. The ECB has five formal public hearings before the European Parliament each year. 

Australia requires a semi-annual testimony and an annual report to the Parliament. In the United 

Kingdom and Japan central bank governors are required to testify, but not at any pre-set interval. 

While testimony does not hold an individual accountable in any formal sense of the word, 

it does require that individual to listen to the opinions of those who are elected by the public at 

large. I think that much of what is called "accountability" really amounts to sensitivity. In the 

formal sense an elected member of the legislature might ask questions in as forceful and 

argumentative a way as he or she might choose, but the central banker has no more obligation 

than to listen politely and give an appropriate answer. There is nothing in this practice that need 

change the central banker's opinion, much less the central bank's policy. 
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Accountability should therefore be thought of in a much broader context, one that feeds 

back into the true basis for the central bank's independence: performance. If a central bank can 

explain what it is doing in a formal hearing or in a regular press conference in a way that strikes 

those interested as reasoned and coherent, then the central bank passes the true test of 

accountability. If the argument being presented makes sense then the markets and the public at 

large are likely to tolerate the central bank pursuing its present course. If rational explanations 

are not forthcoming or if the central bank seems out of touch with the broader line of thinking in 

the country then the bank will quickly lose its freedom of action. So as in the case of 

independence, real accountability is performance based and depends crucially on the ability of 

the central banker to explain the logic of his or her position. 

Communication 

With accountability therefore so dependent on the acceptance by the public and the 

markets of the logical basis of the central bank's thinking, communication has become key. All 

of the central banks considered here issue a formal statement after each meeting. In all cases this 

is followed, with a lag, of a written report of the minutes of the meeting. The Fed, the ECB and 

the Bol also issue economic projections. In the case of the ECB this occurs at every meeting, 

and not just every other meeting as here. The central banks of the United Kingdom, Canada, and 

Australia issue quarterly reports. 

This reporting explains what the central bank is thinking and, to a large extent, the 

reasoning that goes behind that thinking. The issuance of an economic projection attempts to 

quantify that thinking. This is especially important where the central bank is tied or has tied 

itself to some target. For example, if a central bank has an inflation target as part of its mandate, 

it must have an economic projection that shows that the economy is moving toward that target 
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and that the direction of the movement must be consistent with projection and the policy being 

pursued. 

This latter point has now morphed into something known as "'forward guidance" where 

the central bank explicitly projects future policy decisions as well as projections of the path the 

economy is expected to take. The idea behind forward guidance is that it enhances central bank 

effectiveness. For example, the Bank of England, the Bank of Japan, the European Central Bank 

as well as the Federal Reserve now project that interest rates will remain accommodative for 

some extended period into the future. This is to reassure markets that policy will not be 

changing any time soon and that therefore the current level of short term rates set by the central 

bank can be extended further out the yield curve. This is thought to hold intermediate rates 

lower than they otherwise might have been and that this, in turn, will help spur investment and 

the purchase of durable goods. 

It is too early to know whether or not this policy is efficacious. Indeed it will probably 

take the work of some doctoral students in the early part of the next decade to decide the issue. 

But even though there is a general perception that more transparency is always good, it is 

important to consider the possibility that what is being provided may be too much information. 

The key issue is that economics remains as much of an art as a science and too much specificity 

about the future course of policy and the economy runs the risk of showing that the "science" of 

central bank policy making is indeed in its infancy. If markets and the public lose faith in the 

scientific rationale of the policy, then the "art" of shaping economic outcomes through monetary 

policy may be placed at risk as well. 

Let's say hypothetically that economic projections consistently run on the optimistic side 

relative to what actually occurs. Those projections naturally assume that the policy that the 
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central bank is running and plans to continue running have an effect on economic policy and 

presumably that effect is a positive one. But when an economy runs at a rate of growth that is 

consistently below the projections of the central bank it is natural that the question arises as to 

why. There are two logical explanations: either that factors outside the central bank's control 

have consistently, year after year, run to the downside of what was expected or that the efficacy 

of central bank policy is less than what the central bank had projected. Neither explanation is 

good for building faith in the central bank. 

If it is factors outside of the central bank's control then one must ask why the central 

bank's economic model consistently misses the mark. Should the markets and the public have 

faith in a policy process that is built on so flawed a model? The even worse assumption is that 

the policy itself is less efficacious than the central bank assumed. In that case it is rather explicit 

that there is something wrong with the policy itself. 

A second risk of providing too much information is communicating what the central bank 

would do if the situation changes. It is fine to project low interest rates and low inflation into the 

foreseeable future, but what will the central bank do if its inflation projections turn out to be 

wrong? The central bank will have communicated a path of rates that (assuming it has 

credibility) has been incorporated into the market's pricing of intermediate and longer term 

securities. A surprise event that unhinges those expectations therefore will move markets with 

amplified magnitude. Stated differently, the diversity of market opinion that provides liquidity 

and dampens price movements is dissipated by forward guidance. Should the forward guidance 

be wrong, the market reaction will be similar to that in any situation where liquidity is thin and 

most market practitioners are on one side of the trade. 

Objective 
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Where the relationship between communication, accountability, and political 

independence come together most closely is on setting a central bank's objective or mandate. In 

recent years the notion of "price stability" has gained prominence as the central bank objective. 

The Bank of Japan and the Bank of England both have price stability as their target. In both 

cases the definition of price stability is a bit flexible, with low rates of measured inflation being 

the target, typically at a two percent annual rate. The European Central Bank has price stability 

as its "primary objective" with secondary objectives of balanced growth, social progress and full 

employment. It also stipulates that all of those secondary objectives are best achieved through 

price stability. Please note that it is widely accepted in the central banking community as well as 

within the economics profession that low and stable inflation is a necessary condition for other 

objectives such as maximizing employment. The reason is that high rates of inflation lead to a 

reduced rate of efficiency in the economy and that the distortions caused by inflation will 

inevitably lead to a lower equilibrium rate of employment than would otherwise be the case. 

But price stability is not the only objective in the central banking lexicon. Canada has 

adopted a two percent inflation target but its mandate is to "contribute to the economic wellbeing of Canadians". That has to be one of the most nebulous and broad mandates possible, but 

it does not stand in the way of price stability as a target. Australia mandates stability of the 

currency, full employment, and economic prosperity. Here there is some question about what is 

meant by stability of the currency since the foreign exchange value of the Australian dollar is one 

of the main shock absorbers of the economy. It rose sharply during the China boom and is now 

falling rapidly as Chinese growth slows down. This is hardly a "stable currency" but its 

flexibility also helps maintain employment and economic prosperity. 
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Frankly, this comparison indicates that probably too much attention is being paid to 

defining a central bank's mandate. Central banks are going to do what central banks are going to 

do. Although far from specific, the Canadians probably have it right. Central banking behavior 

is designed to "contribute to the economic wellbeing" of the country. There is a broad consensus 

that this includes a focus on price stability - or more precisely low measured inflation - but that 

the so-called inflation target is really just a pre-requisite for other objectives like growth and 

employment. And, to reiterate a point made earlier, when it comes to setting objectives, 

financial stability is the prime directive of the central bank. Formal mandates and targets have 

given way to the pursuit of this central purpose for both philosophical and pragmatic reasons. 

All of the central banks considered here have relied on the setting of short term interest 

rates as their primary policy tool. This has been the chief policy tool since the central bank is 

both a short term lender of last resort to the banking system, and more broadly, a major 

participant in the overnight lending of one bank to another. By controlling that overnight rate 

through its intervention, the central bank tends to set a base price for lending by banks to other 

agents in the economy and therefore influence the level of economic activity. 

It used to be thought that controlling the short term lending rate was sufficient for the 

conduct of monetary policy. If the short term rate was appropriately anchored, longer term rates 

in the economy would vary with market perceptions of longer term risks, including the risk of 

future policy changes by the central bank. The various asset purchase programs now used by the 

ECB, the Bol, the Bank of England and the Fed are designed to directly control these longer 

term rates as well. 
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Part of the reason for extending the term structure of central bank purchases was purely 

pragmatic. The volume of monetary policy intervention that the central bank deemed 

appropriate was often in excess of what was available on the short end of the yield curve. 

Quantitative Easing is deemed necessary as short rates approached their zero lower bond since it 

is widely believed that the optimum short term rate should actually be below zero for monetary 

conditions to be appropriate in meeting the central bank's longer term objectives. 

Indeed, even the purchase of longer term government bonds has now been considered 

insufficient for most of the world's leading central banks. The ECB, which normally could not 

make such purchases, now utilizes its L TRO program to lend money to banks on a long term 

basis in order to purchase government bonds indirectly. In addition, it has a covered bond 

purchase program that purchases both mortgages and other public sector bonds. The Bank of 

Japan purchases ETFs in the equity market as well as Real Estate Investment Trusts. The Bank 

of England makes loans to banks based on the amount of their private sector lending. 

One would hope that the use of all of these tools would be temporary in nature. They 

were implemented to deal with what everyone considered an extraordinary situation. We are 

indeed in big trouble if the extraordinary begins to transition into the ordinary since it will mean 

that more than just central bank policy making has some serious problems. Again, a review of 

the behavior of central banks globally suggests that flexibility in the tools they might use is a 

good idea because when extraordinary situations develop it is probably not a good idea to hobble 

central bank policy making unnecessarily. An example of this is in the Eurozone where the ECB 

is constrained in its ability to conduct Quantitative Easing due to prohibitions on its ability to 

purchase government bonds in large scale. 
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That said, one area that might be a bright line to watch is credit allocation. It is one thing 

for central banks to conduct monetary policy through the purchase of large amounts of 

instruments, it is quite another for the central bank to decide who is a good credit and who is not. 

The reason that banks and credit markets are assigned that job is that the lender puts itself at risk 

and therefore has a stake in the quality of its credit decision. The same would not necessarily be 

true of the central bank. 

There is of course a lot to discuss in this area, but I hope this has provided some basic 

guideposts as to the international conduct of central banks. I would be happy to answer your 

questions. 
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11125113 Andrew Huszar: Confessions of a Quantitati>.e Easer ~ WSJ,com 

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THE WALL STREET JOURNAL. OPINION 

Andrew Huszar: Confessions of a Quantitative Easer 

We went on a bond-buying spree that was supposed to help Main Street. Instead, it was a 

feastfor Wall Street. 

By ANDREW HUSZAR 

Nov. 11,20137:00 p.rn ET 

I can only say: I'm sorry, America. As a former Federal Reserve official, I was responsible for executing the 

centerpiece program of the Fed's first plunge into the bond-buying experiment known as quantitative easing. 

The central bank continues to spin QE as a tool for helping Main Street. But I've come to recognize the 

program for what it really is: the greatest backdoor Wall Street bailout of all time. 

Five years ago this month, on Black Friday, the Fed launched an unprecedented shopping spree. By that 

point in the financial crisis, Congress had already passed legislation, the Troubled Asset Relief Program, to 

halt the U.S. banking system's free fall. Beyond Wall Street, though, the economic pain was still soaring. In 

the last three months of 2008 alone, almost two million Americans would lose their jobs. 

The Fed said it wanted to help-through a new program of massive bond purchases. There were secondary 

goals, but Chairman Ben Bernanke made clear that the Fed's central motivation was to "affect credit 

conditions for households and businesses": to drive down the cost of credit so that more Americans hurting 

from the tanking economy could use it to weather the downturn. For this reason, he originally called the 

initiative "credit easing." 

My part of the story began a few months later. Having been at the Fed for seven years, until early 2008, I was 

working on Wall Street in spring 2009 when I got an unexpected phone call. Would I come back to work on 

the Fed's trading floor? The job: managing what was at the heart of QE's bond-buying spree-a wild attempt 

to buy $1.25 trillion in mortgage bonds in 12 months. Incredibly, the Fed was calling to ask if I wanted to 

quarterback the largest economic stimulus in U.S. history. 

This was a dream job, but I hesitated. And it wasn't just nervousness about taking on such responsibility. I 

had left the Fed out of frustration, having witnessed the institution deferring more and more to Wall Street. 

Independence is at the heart of any central bank's credibility, and I had come to believe that the Fed's 

independence was eroding. Senior Fed officials, though, were publicly acknowledging mistakes and several 

of those officials emphasized to me how committed they were to a major Wall Street revamp. I could also 

see that they desperately needed reinforcements. I took a leap of faith. 

In its almost 1 ~O-year history, the Fed had never bought one mortgage bond. Now my program was buying 

so many each day through active, unscripted trading that we constantly risked driving bond prices too high 

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11/25113 Andrew Huszar: Confessions of a Quantitathe Easer· WSJ.com 

and crashing global confidence in key financial markets. We 

were working feverishly to preserve the impression that the 

Fed knew what it was doing. 

n wasn't long before myoid doubts resurfaced. Despite the 

Fed's rhetoric, my program wasn't helping to make credit any 

more accessible for the average American. The banks were 

only issuing fewer and fewer loans. More insidiously, whatever 

credit they were extending wasn't getting much cheaper. QE 

may have been driving down the wholesale cost for banks to 

make loans, but Wall Street was pocketing most of the extra 

cash. 

From the trenches, several other Fed managers also began 

Phil Foster voicing the concern that QE wasn't working as planned. Our 

warnings fell on deaf ears. In the past, Fed leaders-even if 

they ultimately erred-would have worried obsessively about the costs versus the benefits of any major 

initiative. Now the only obsession seemed to be with the newest survey of financial-market expectations or 

the latest in-person feedback from Wall Street's leading bankers and hedge-fund managers. Sorry, U.S. 

taxpayer. 

Trading for the first round of QE ended on M<lrch 31, 2010. The final results confirmed that, while there had 

been only trivial relief for M<lin Street, the U.S. central bank's bond purchases had been an absolute coup for 

Wall Street. The banks hadn't just benefited from the lower cost of making loans. They'd also enjoyed huge 

capital gains on the rising values of their securities holdings and fat commissions from brokering most of the 

Fed's QE transactions. Wall Street had experienced its most profitable year ever in 2009, and 2010 was 

starting off in much the same way. 

You'd think the Fed would have finally stopped to question the wisdom of QE. Think again. Only a few 

months later-afier a 14% drop in the U.S. stock market and renewed weakening in the banking sector-the 

Fed announced a new round of bond buying: QE2. Germany's finance minister, Wolfgang ScMuble, 

immediately called the decision "clueless." 

That was when I realized the Fed had lost any remaining ability to think independently from Wall Street. 

Demoralized, I returned to the private sector. 

Where are we today? The Fed keeps buying roughly $85 billion in bonds a month, chronically delaying so 

much as a minor QE ill!lllJ:. Over five years, its bond purchases have come to more than $4 trillion. 

Amazingly, in a supposedly free-market nation, QE has become the largest financial-markets intervention by 

any government in world history. 

And the impact? Even by the Fed's sunniest calculations, aggressive QE over five years has generated only 

a few percentage points of U.S. growth. By contrast, experts outside the Fed, such as Mohammed EI Erian 

at the Pimco investment firm, suggest that the Fed may have created and spent over $4 trillion for a total 

return of as little as 0.25% of GDP (Le., a mere $40 billion bump in U.S. economic output). Both of those 

estimates indicate that QE isn't really working. 

Unless you're Wall Street. Having racked up hundreds of billions of dollars in opaque Fed subsidies, U.S. 

banks have seen their collective stock price triple since M<lrch 2009. The biggest ones have only become 

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11/25113 Andrew Huszar: Confessions of a Quantitati>e Easer· WSJ.com 

more of a cartel: 0.2% of them now control more than 70% of the U.S. bank assets. 

As for the rest of America, good luck. Because QE was relentlessly pumping money into the financial 

markets during the past five years, it killed the urgency for Washington to confront a real crisis: that of a 

structurally unsound U.S. economy. Yes, those financial markets have rallied spectacularly, breathing muchneeded life back into 401 (k)s, but for how long? Experts like Larry Fink at the BlackRock investment firm are 

suggesting that conditions are again "bubble-like." Meanwhile, the country remains overly dependent on Wall 

Street to drive economic growth. 

Even when acknowledging QE's shortcomings, Chairman Bernanke argues that some action by the Fed is 

better than none (a position that his likely successor, Fed Vice Chairwoman Janet Yellen, also embraces). 

The implication is that the Fed is dutifully compensating for the rest of Washington's dysfunction. But the Fed 

is at the center of that dysfunction. Case in point: II has allowed QE to become Wall Street's new "too big to 

fail" policy. 

Mr. Huszar, a senior fellow at Rutgers Business School, is a former Morgan Stanley managing director. In 

2009-10, he managed the Federal Reserve's $1.25 trillion agency mortgage-backed security purchase 

program. 

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