charles i plosser : restoring central banks after the crisis speech by mr charles i plosser, president and chief executive officer of the federal reserve bank of philadelphia, at the conference of the global interdependence center / bank of france, paris, 26 march 2012. * * * the views expressed today are my own and not necessarily those of the federal reserve system or the fomc. introduction i am delighted to be here today in this beautiful city and to have the honor to serve on such a distinguished panel with friends and colleagues. david kotok has been the guiding force behind the gic conferences over the past several years. he and his team at the gic never fail to gather an interesting and knowledgeable group of people to discuss important topics on truly global issues. so, i want to thank him and the gic for their efforts and contributions. i also want to thank our hosts, christian noyer and the banque de france. i am going to take a little different tack on the subject matter of this gathering. rather than focus on what new orthodoxy we should take away from the financial crisis, i want to argue that we need to restore some of the old orthodoxy. david did suggest that he wanted to have a conversation on important issues, so i intend to be somewhat provocative in an effort to stimulate such conversation. as usual, i want to stress that my views are my own and not necessarily those of my colleagues in the federal reserve system. i will focus my remarks on two related topics that have emerged as a consequence of the crisis. the first is the relation between monetary policy and fiscal policy. the second topic involves the role of a central bank ’ s balance sheet as a policy tool. these are issues that i believe are of fundamental importance to the role of central banks in our economies. the relationship between monetary and fiscal policies let me begin by sharing some thoughts on the appropriate relationship between monetary and fiscal policies. in the wake of the financial crisis and the ensuing recession, many countries around the world responded with a significant increase in government spending. some of this increase came about through what economists call automatic stabilizers. but there has also been a dramatic expansion in budget deficits attributable to deliberate efforts to apply fiscal stimulus to improve economic outcomes. this expansion in government spending has been very significant in the u. s., but it has also occurred in other countries. so what does this have to do with monetary policy? well, it turns out

those objectives. granting vast amounts of discretion to our central banks in the expectation that they can cure our economic ills or substitute for our lack of fiscal discipline is a dangerous road to follow. in june, the federal reserve ’ s open market committee outlined some principles that would guide its exit from this period of extraordinary monetary accommodation. in my view, those principles represented an important first step in the fomc ’ s attempt to restore the boundaries between monetary and fiscal policies. in particular, the fomc clearly stated its desire to return to an operating environment in which the federal funds rate is the primary instrument of monetary policy. to achieve that objective, the fed will have to shrink its balance sheet to a more normal level. i interpret this as saying that our balance sheet should not be viewed as a new independent instrument of monetary policy in normal times. the exit principles also indicated the committee ’ s desire to return the fed ’ s balance sheet to an all - treasuries portfolio. this re - establishes the idea that the fed should not use its balance sheet to actively engage in credit allocations. in other speeches, i have outlined a framework that i have termed a “ new accord ” between the federal reserve and the treasury. it would enable the central bank to act in emergencies when requested by the treasury or the fiscal authorities, but it would be clear up front that any non - treasury assets that accrued on the central bank ’ s balance sheet would be swapped for government securities within a specified period of time. this would ensure that fiscal policy decisions remain under the purview of the fiscal authorities, not the central bank. summary to summarize, it is important for governments to maintain independent central banks so that they are better able to achieve their mandates. it is also sound policy to limit the discretionary ability of central banks to engage in policies that fundamentally belong to fiscal authorities or private markets. establishing and maintaining clear boundaries between monetary and fiscal policies protects the independence of the central bank and its ability to carry out its core mandate – maintaining price stability. clear boundaries and resisting the use of the balance sheet as a new policy tool would also improve fiscal discipline by making it more difficult for the fiscal authorities to resort to the printing press as a solution to unsustainable budget policies. bis central bankers ’ speeches