Boris Vujčić: The role of central banks and how to insure their
independence
Speech by Mr Boris Vujčić, Governor of the Croatian National Bank, at the Symposium on
"Central Banking in Central and Eastern Europe: Policy Making, Investment and Low Yields",
organized by the Czech National Bank and OMFIF (Official Monetary and Financial
Institutions Forum), Prague, 10 June 2016.
* * *
I would like to thank Katja Gattin Turkalj and Vedran Šošić for their help in preparing the speech and Relja Martić
and Tomáš Holub for their useful comments and insights. The opinions expressed in the text are entirely mine.
Dear colleagues,
Dear Mirek, Dear David,
Thank you for the invitation. I stand here in front of you with a bit of mixed feelings. I am
always happy to be with you, always happy to be in the wonderful Prague, at the CNB, but at
the same time it is not easy to bid farewell to a fellow Governor and a friend.
The idea for me to say a few words on this occasion about central bank independence was
not mine, but I endorsed it immediately. No central banker would refuse to talk about the
central bank independence. This topic was not chosen by coincidence. The role of central
banks has greatly changed from before the Great Financial Crisis, and central bank
independence is today being challenged from many directions. As David already mentioned
today, central banks seem to have been the only game in town for quite some time now. Why
is that so? There is an old joke about a guy who comes to visit a friend in the evening and
sees him kneeling on the grass in his yard and searching for something. He asks him what
happened. A friend replies: "I lost my keys." He asks him: "Did you lose them here?" "No,"
the friend replies - "on the opposite side of the yard." "So, why are you searching for them
here?" Because this is where the light is." This may be the best answers to the question why
there has been so much focus on monetary policy over the last seven years.
What did central bankers banks get into a situation where they have to worry again
about the independence of monetary policies? There are at least three reasons. First,
prior to the crisis, there was a large build-up of private debt, and during the crisis also of
public debt. Second, the existing monetary policy instruments are now put in use for a much
broader scope than before, with marked redistributive consequences. Third, central banks
were given new mandates, primarily in the area of financial stability, making them policy
makers of last resort. As a consequence, central banking has entered a new, challenging
and, I dare say, even perilous period.
Let me briefly elaborate on each of these points.
The role of central banks today has greatly changed from before the Great Financial
Crisis. The sources of challenges faced by central banks can be provisionally divided into
those idiosyncratic to monetary policy (e.g., it is harder to conduct monetary policy with low
interest rates), those that are "secular", due to an altered economic reality (e.g., a high
leverage in a short to medium term, or unfavourable demographic trends in a longer term)
and to their interactions.
Central banks today operate in an environment of extremely low interest rates and
high indebtedness of both the private sector and sovereigns, which narrows their
maneuvering space. Yet they are expected to shoulder ever-increasing policy burdens, which
is referred to as "mandate creep" (Gürkaynak & Davig, 2015).
First, over the last couple of decades central banks have stewarded the world
economy through a period of rapid private debt build-up, which in many emerging
markets continued during the crisis, followed by a rise in public debt during the crisis.
Indebtedness is at historically high levels. Such an environment of high public and private
indebtedness has a two-way relation with monetary policy: ex ante, monetary policy,
generally, might have been too lax before the crisis and contributed to excessive leveraging,
while it is nowadays, ex post, considered as a key for debt sustainability. Nonetheless,
central banks will not run out of ammo as long as they command the printing press. But,
more importantly, regardless of the amount of ammo used, central banks may still fall short
of reaching their objectives (Shin, 2016).
Second, the existing instruments are put in use for a much broader scope than before,
with marked redistributive consequences. Previously, prior to the Great Financial Crisis,
redistributive consequences had been annulled over the cycle i.e. affected only the
intertemporal choices of a representative agent. In contrast, in today's protracted era of low
interest rates, monetary policy has strong and direct distributional consequences. No wonder
then that there is so much discussion on monetary policy and inequality these days
(Bernanke, 2015; Bullard, 2014; Coibion, Gorodnichenko, Kueng, & Silvia, 2012; Mersch,
2014; Yellen, 2014).
Furthermore, the ideas which have been recently pushed forward, such as the "QE for
the people", centre around growing inequalities and the (perceived) failure of the QE
to jumpstart the economy. Such initiatives promote ideas such as "helicopter money", but
also "infrastructure investment" and alike. One of the characteristics of these initiatives is
their quasi-fiscal nature, as such policies would have direct redistributive consequences.
This is unlike low or negative interest rates, or indeed the QE itself, which do not have
first order redistribution effects. Which, of course, is not to say that they do not have any
redistributive consequences. "As long as assets are unevenly spread across the population,
shifts in their prices will have redistributive effects..." (Broadbent, 2014). However, it is a
very different world in which non-elected technocrats would have a mandate to do an
outright redistribution implied by such initiatives. It seems that it has become a
communicational challenge to convey that central banks simply do not have a mandate to do
so.
Third, central banks have been given a new mandate, primarily in the area of financial
stability. This mandate is far broader than the "lender of last resort". Some of the
new/old macroprudential instruments indirectly affect depositors and debtors (e. g. higher
capital or liquidity requirements), while others have a more direct effect by affecting the credit
alocation (for instance, loan-to-value or debtservicing ratios). Moreover, the degree to which
the goal of financial stability is fulfilled is very hard to objectively measure and quantify. The
distributional impact of financial stability policy is often more central to its effectiveness than
is the case with monetary policy. Macroprudential tools have distributional effects that are
central to their success. In recent times, after the global financial crisis (GFC), and after the
realization that prudential policies were often not where they should have been before the
crisis, we have seen a reversal of the trend of extracting supervision outside of central banks,
and the trend of returning it back to central banks. That was a useful lesson. In the case of
the Czech National Bank, as with most Central and East European central banks,
supervision has always been within the central bank. Moreover, in 2006, the CNB started to
supervise the whole financial system, including insurance companies, pension funds and
investment funds (after a merger with the Security Exchange Commission and a supervision
office of the Ministry of Finance). It was under Governor Tůma's mandate and Mr. Singer
was Vice-Governor at that time. And it seems that nobody should have any complaints with
regard to this, as today the Czech financial system is both efficient and stable.
Central bank independence, of course, has been a controversial concept for much
longer than the current discussion. It requires the delegation of powerful authority to a
group of unelected officials, in order to prevent the redistributive consequences of
inflation. More techically, an independent central bank is a device to overcome the problem
of time consistency: the concern that policymakers will in future renege on a policy promise
made today. These consequences, especially in the case of hyperinflation, can be
devastating for the economy, and can also have a deep political impact, as we have
witnessed in the past. Now, with the financial crisis, an earlier rationale for central bank
independence has also re-emerged: the need to prevent or limit panics.
Consequently, there is an unavoidable conflict between the goals of democratic
legitimacy and policy effectiveness (Cecchetti & Schoenholtz, 2015). In other words, the
"anomaly" of powerful authority being in the hands of unelected officials naturally raises
questions of legitimacy and fears of the concentration of power in the hands of a select few.
All of these can trigger a popular discontent as has recently been experienced.
Issues on democratic legitimacy arise primarily within the redistributive realm of
monetary policy, i.e. when monetary policy does somebody else's job. Ironically, had
there not been for the expansion in both the mandates (formal as well as informal) and
expectations of central bank policies, the issues of independence and democratic legitimacy
would not have surfaced with such intensity.
Further challenges arise from the lack of ability to quantify numerically the resilience
of the financial system in the same way as inflation is quantified as a monetary policy
goal. This is especially true if judging the state of financial stability requires knowledge of
privileged information about individual institutions that a financial supervisor cannot disclose.
As a result, outside observers will find it difficult to assess objectively the progress toward
financial stability. Most of the observers find the monetary policy goal - price stability - easier
to interpret, no matter how complex measuring price stability and understanding the impact
of interest rate changes may be. To make an independent central bank work, political leaders
must delegate the necessary powers and establish an oversight regime that ensures
accountability without undermining the institution's policy effectiveness (Cecchetti &
Schoenholtz, 2015).
Central to the issue of price stability as a monetary policy goal is the real impact of
low inflation on the economy, which, it seems to me, we still do not know much about.
There is little or no evidence that low inflation, or small deflation, hurts growth. Nor do we
know much about the ability of monetary policy to affect the inflation rate in a globalized
world in which, on the one hand, we have a global pool of liquidity, and, on the other,
competitive pressures arising from all corners of the world, based on significantly improved
global allocations of capital and labour and differential productivity growth rates.
New economic circumstances and new instruments and mandates create new
challenges with implications for central banks' independence, particularly within
multinational currency zones/monetary communities. But distribution conflicts spill over to
monetary policy even within a single country. For example, due to strong pre-crisis borrowing
(some) households got heavily leveraged prior to the crisis. The subsequent fall in real estate
prices led to a part of households getting "under water". Given that financial assets are far
more concentrated than loans, the two groups of households would prefer different, if not
completely opposite monetary policy stances.
When it comes to financial stability issues, a recent set of government interventions in
Central and East Europe in issues bearing repercussions on financial stability marks
another challenge. The Hungarian conversion of CHF loans, followed by the Croatian one,
the Romanian introduction of "limited liability" (non-recourse) mortgage loans with a
retroactive effect or a recent discussion in Poland on bank taxes and the conversion of CHF
loans. Such a political economy might challenge the conduct of monetary policy and
supervision, where the main objective is the stability of the banking system and, indeed, a
prevention of public funds being spent on insured savings.
Is it possible that central banks will try to "optimize" independence by making new
circumstances endogenous? For example, they might start treating inflation target more
flexibly, while simultaneously trying to achieve other, not legally mandated goals, such as
debt reduction. The reduction of an aggregate debt overhang could be fast, although painful
in the short-term, through some form of debt restructuring. Alternatively, the slow method
entails that the borrowers' income growth exceeds the rate of interest, while the debt stock is
kept fixed. This is colloquially termed "growing out of debt".
This "new reality of lost central bank independence" has already been voiced by many
economists. They claim that if central banks do not adapt to new realities, the political
paradigm about the acceptable model of central bank autonomy may change.
Blancheton (2016) qualifies this as "tacit low-degree independence", claiming that central
banks have "endogenized the necessity of participating in the liquidation of public debt", and
points to the history of central banking, "which shows that the balance of power with
governments is, under such circumstances, inevitably unfavourable". In the same manner,
Wren-Lewis (2016a, 2016b) attributes the loss of independence to central banks themselves,
as they did not see a massive increase in financial sector leverage - "That should have rung
alarm bells, but instead it produced at most muted notes of concern about attitudes to risk" -
then they stood by during the premature fiscal consolidation and obsessive austerity and,
finally, adjusted demand to the incorrectly perceived low level of supply.
The competing view is that central banks have done a good job with monetary policy,
in extremely challenging circumstances, and have even managed to strengthen
independence. One venue for that is within institutional arrangements that share the
responsibilities for supervision and macroprudential policies, be it national or international
bodies of cooperation that have strengthened and standardized prudential regulation, thus
making national capture, either political or coming from industry, less likely.
In order not to jeopardize their independence, for example by being complicit when accepting
to do somebody else's job, central banks have to be cautious in expanding their mandates
and mindful of redistributive effects inherent to non-orthodox monetary policies, negative
interest rates, macroprudential policy, and so on. The moment central banks consciously
embark on that road, or "turn a blind eye" to redistributive effects in the name of higher goals,
they risk losing their independence.
Additionally, transparency, as a traditional response to strengthen central bank
independence, might not be sufficient. The blow to independence only partially comes
from ignorance, it is to a higher degree caused by strong economic interests. Nonetheless,
central banks need to further the understanding of the new economic realities and
circumstances. Intellectual capacities and knowledge are often the best defense mechanism
of central banks.
In the end, let me now say a few words about the CNB.
The Czech National Bank, headed by Miroslav, has also tested the limits of
independence against non-orthodox views, and sometimes against the mood of the
Czech general public, which is traditionally very conservative in monetary matters. When the
Czech National Bank decided to establish the current exchange rate commitment, it was
exposed to quite a serious criticism at home. Fears immediately arose that everything would
become more expensive and that the fragile recovery of the Czech economy would be
undermined. Some "expert" commentators, for example, claimed that foreign holidays of the
Czech people would become 15% more expensive after a 5% currency depreciation, as they
would need to pay 5% more to the travel agent, 5% more for swimming dresses and
suntanning creams, as well as 5% more for calamari and ice-cream at the beach. But as Mirek
himself put it, that was a time when the Czech National Bank could actually make full use of
its independence, which allowed it to do things that might be unpopular in the short term, but
prove to be beneficial in the medium term.
The CNB approached all its battles, either in the area of monetary policy, or regarding
institutional issues, even when it looked as David vs Goliath - or Sparta Praha against Real
Madrid - fearlesly, well prepared, armed with thorough research, underpinned by theory, with
the assertivenes possessed only by those who strongly believe that the right is on their side.
So, this is not a farewell, but a new beginning. We are not losing one of our own, a fellow
Governor and a friend who has been in the trenches with us. We are gaining a powerful ally
in you, Mirek, whatever your next position is.
Thank you and see you soon.
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