Jürgen Stark: Future trends in central banking
Dinner Speech by Dr Jürgen Stark, Deputy Governor of the Deutsche Bundesbank, at the Conference
"The next 25 years in African Economic Development", Bank of Botswana, on 6 July 2000.
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Your excellencies, ladies and gentlemen,
It gives me great pleasure to convey the congratulations of the President and the entire Deutsche
Bundesbank on the 25th anniversary of the founding of the Bank of Botswana. I am aware that the
Bank of Botswana, with its stability-oriented monetary policy - the conditions for which were
improved still further in 1997 following the modernisation of the Bank of Botswana Act - has for
years been making a substantial contribution to the much above-average performance of the
Botswanan economy in Africa, even if a number of structural adjustments still need to be made. With
its responsible budgetary policy and well-developed democratic system, Botswana is a widely-rated
model for Africa.
"Who does not know the past, will not come to terms with the future",1 said Golo Mann, a well-known
German historian and publicist, some years ago. That statement is also true of the future of central
banking. Let me therefore start with a brief look back at the recent history of central banking as a
starting point for highlighting some aspects of the challenges that will face us in future.
In the middle of the 20th century, after the end of the Second World War, Germany - perhaps more
than any other country - was searching for a new economic policy paradigm that would mark out a
course for the future. At that time, a decision was made (at least in the western part of Germany) in
favour of implementing That decision - as the Wirtschaftswunder, Germany's
free market principles.
much-cited "economic miracle" showed - was to produce notably successful results.
Apart from those fundamental policy decisions that set the future course for a market economy,
however, that notable success was also due to an unqualified
commitment of monetary policy to the
Following the devastating experience of war inflation, and after the
objective of price stability.
subsequent currency reform, the parliament of the young Federal Republic of Germany made that
price-stability objective the primary task of the newly established central bank. This decision was
anything but a matter of course at a time when Keynesianism was shaping economic policy thinking
not only in most other industrial countries but also in the Federal Republic of Germany itself. The
Federal Republic's monetary approach and the perception of the Bundesbank's role and task acting
together with those who bear political responsibility were - as we are now aware - far ahead of their
time.
That is true not only in terms of the primary commitment to the objective of price stability but also
with regard to the instruments and the regulatory framework in which the central bank acted. The
central banks and governments in most industrial countries were placing their trust in the
administrative management of monetary and financial activity by attempting to influence financial
flows - domestically, by means of selective credit controls and interest-rate regulations and, externally,
by imposing capital controls. In the Federal Republic of Germany, by contrast, the opening-up of
borders for capital movements and the liberalisation of interest rates began at an early stage. At that
time, the foundations were laid for the D-Mark's subsequent reputation and attractiveness, which was
to make the young German currency the second most important international investment and reserve
currency next to the US dollar - something which happened more quickly than seemed desirable in the
light of financial markets which were then still "underdeveloped" in some respects.
How much ideas about an efficient monetary policy varied within the group of industrial countries
during the post-war period became very clear in the seventies. Economic policy thinking at the time
was that a given level of output - and thus full employment - could be achieved at any time if only the
right mix of monetary and fiscal policies were to be deployed. Inflation was understood more as a
"lubricant" of dynamic economic growth and not as an undesirable development which, in the longer
run, results in severe losses of growth and welfare. It took until the end of the seventies before there
was a broad acceptance of the bitter finding that unemployment cannot simply be combated by higher
inflation. The markets quickly saw through the fact that monetary policymakers were playing with the
money illusion of the market participants - on which the Keynesian approach relied.
In effect, monetary policy in many countries at the end of the seventies was faced with the "wreckage"
of high inflation and high unemployment as well as growing losses of credibility. In many cases, the
Keynesian experiment was bought at a high price.
In the light of those realisations, there was a fundamental paradigm change in monetary policy in the
later seventies and early eighties in favour of an approach unambiguously geared to price stability. At
the same time, the set of monetary policy instruments was brought more closely into line with market
conditions, and interest rates in the financial markets as well as cross-border capital transactions were
liberalised. This sea change in monetary policy was accompanied by a general reorientation of
economic policy which compelled the government to concentrate on its primary functions, thus
creating greater scope for the development of market forces. This reorientation of monetary policy has
not been without success. During the past twenty years, inflation has been reduced to a much more
acceptable level in the industrial countries, thus making it possible to speak at least virtually of price
stability in the majority of countries.
Over the past few decades there has arisen an international consensus about monetary policy that is
geared to price stability. The evident success of such a policy in the nineties paved the way for a single
monetary policy in Europe. As a result, with the start of European monetary union at the beginning
of 1999 the conditions for tension-free broad-based growth have improved.
The experience of German monetary policy and that of other central banks has taught us that, besides
the unambiguous commitment to the objective of price stability, the independence of the monetary
policy decision-makers is a basic precondition for that success. Independence means, first of all, that
the central bank is independent of the government in formal terms with regard to the deployment of its
monetary policy instruments. The Maastricht Treaty provides the European System of Central Banks
with an even greater degree of independence, in fact, than was stipulated earlier by the legislators of
the Bundesbank Act. The central bank's formal independence of the government has to be
accompanied by material independence which ensures that the monetary policy decision-makers can
take their decisions in isolation from the interests of the government. For that reason, the agreements
on European monetary union provide for terms of office for the ECB's management that are of
adequate length and rule out premature dismissal. Furthermore, the independence of monetary policy
in Europe is protected by the Maastricht Treaty prohibiting the ECB from financing budgetary deficits
and by the fact that the exchange-rate arrangements of the governments are clearly subordinated to the
primary objective of price stability.
After roughly 18 months, in which responsibility for monetary policy has resided with the European
Central Bank, it is undoubtedly still too early for an overall assessment. However, the fact that the
changeover to the euro took place so smoothly can already be put down as a success. Moreover, the
interest-rate decisions of the ECB Governing Council since last autumn have demonstrated the
promptness and determination with which the ECB is countering signs of inflationary tensions. We
may be confident that the central banks participating in EMU and the ECB constitute a reliable
bulwark against inflation. In saying that, we have to guard against misconceptions. The danger of
inflation is not dead simply because the current statistics are showing comparatively stable prices for
most of the industrial countries. The fight against inflation will not have been won until inflation has
disappeared once and for all from the range of attractive policy options. The struggle to create a stable
environment remains the prime task of the central banks.
Does that mean "business as usual"? No, that is certainly not how I see the
future of central banking.
The increasing globalisation of the markets and the resulting structural changes mean that the central
banks are facing challenges on a scale that cannot easily be grasped at present. It is possible that we
shall be forced to recognise that the move in monetary policy towards instruments that are more in line
with the market - which was, in principle, very much welcome - may cause difficulties that we cannot
yet properly assess in an environment in which market conditions have changed. What will be the
implications, for example, if the traditional funding of enterprises by credit institutions is increasingly
replaced by funding through other financial intermediaries and from other sources, such as insurance
enterprises and securities issues, which are not subject to direct monetary policy control? And what
will be the implication for monetary policy if the term "money stock" simply slips out of our grasp
because no one is able to say any longer with any certainty what money is or what it is not? Just think
of the possibilities of the Internet and the increasing use of electronic money. What repercussions will
this have on the transmission channels of monetary policy and, by extension, on the effectiveness of
monetary policy?
Above all, the and the increasing blurring of boundaries
fiercer competition in the financial markets
between money and other financial assets, and between banks and non-banks will reduce individual
institutions' scope to set their own interest rates. In other words, in future it will be more difficult for
the banks to pass on the central bank's interest-rate moves to their customers with a time lag or only to
a limited extent. This is likely to result in monetary policy stimuli being transmitted more quickly via
the interest-rate channel, which is fundamentally welcome from the point of view of the central bank.
Nevertheless, this will bring about changes to the established mechanisms of the transmission process,
which might - at least for a time - give rise to certain problems of interpretation for monetary policy.
Furthermore, the increasing securitisation of assets means that greater attention will have to be given
to the impact of central bank policy on the capital market rate and its implication for the real sector.
But we shall probably have to adjust to the fact that the increasing growth and use of the internet is
opening up new possibilities in the financial sector which are not without risk from the point of view
of the central banks. The growing use of e-money in payments may, at times, lead to some problems
of data interpretation. As long as flows of e-money are dominated by domestic banks, however, this
will not result in any lasting impairment of monetary policy, since we possess the instrument of - by
all means, remunerable - minimum reserves. At all events, the existence of minimum reserves ensures
that broader monetary aggregates remain closely related to the provision of central bank money.
Consequently, it will be important to create the statutory framework for making all enterprises wishing
to issue e-money subject to banking supervision and minimum reserve requirements.
The situation would be somewhat different if, say, residents were to use money supplied by a
non-resident issuer for domestic transactions on a significant scale. This might loosen the relationship
between the national money stock and the domestic transaction volume and cause the money stock
indicators to lose some of their informative value. On the other hand, the processing of payments
abroad harbours new risks for the market players - risks that make a sharp growth in such
arrangements appear, if anything, unlikely on account of differences in the legal frameworks for the
guaranteeing of deposits, for example. Thus, it can hardly be assumed that the emerging changes will
descend on us abruptly without us being able to respond. The volume of e-money issued is, at all
events, still very small at present.2
In summary I would like to reiterate three points:
1. There is now a worldwide consensus that monetary policy - as independent as possible of
political influence - should be committed primarily to the objective of price stability. The
experience of the industrial countries in the 1960s and 1970s, at least, showed that an
inflationary policy only harms the development of the economy. Or to put it another way:
price stability is the best precondition for sustained growth.
2. The benefits of the paradigm change that took place in the late seventies and the early
eighties are now becoming apparent. Inflation has been largely brought under control and, in
most industrial countries, it is more or less already possible to speak of price stability. That
does not mean, of course, that we central bankers have to fear that we shall soon become
superfluous. Price stability is a good that has to be earned every day anew - vigilance is
therefore still the prime necessity for monetary policymakers.
3. But in another respect, too, there is no cause for us to be complacent or satisfied with
ourselves and take a back seat. New challenges are on the horizon. I see no occasion for
pessimism, however, when faced with the advancing globalisation of the financial markets
and intensifying competition in the financial sector: they may call for flexible adjustments
and changes but are not a fundamental impediment to an effective monetary policy.
Established economic relationships may change or become looser, but this will not prevent
monetary policymakers from being effective in performing their task of ensuring the internal
stability of their own currency in the future as well.