No hawks or doves, just owls
By Scott Sumner
Here is Germany’s representative at the ECB, Jens Weidmann:
Mr. Weidmann’s conservative stance contrasts with the ECB’s latest attempts to convince investors that it will act forcefully to boost the flow of money to the economy, and may raise doubts about the bank’s ability to gain the consensus to do still more expansive steps if needed. He warned of the danger of relying too much on central banks to solve economic problems.
“There is a risk of monetary policy, especially in the euro area, being held hostage by politics,” Mr. Weidmann said in an interview conducted Monday at the Bundesbank in Frankfurt, just a few miles from the ECB.
. . . In sharp contrast, Mr. Weidmann in the interview stressed that the Bundesbank’s hard-money, conservative philosophy remains relevant despite repeated financial crises in recent years that prompted central banks around the world to experiment with policies such as asset purchases. “The concept of an independent central bank clearly focused on price stability is neither old-fashioned nor outdated,” he said. “It is about not falling into the trap of ‘This time is different.’ “
At this point you might be yawning. Yes, Weidmann’s a hawk, and he’s expressing hawkish views. What’s so strange about that? OK, but consider that if you take the ECB’s inflation mandate seriously, then none of Weidmann’s views make any sense. His “hard money, conservative philosophy” is as irrelevant as his religion, or the football team he roots for. Even by just mentioning these views the reporter is implying Weidmann is corrupt. If you take the mandate seriously there should be no hawks and doves. Here is how it is supposed to work:
1. ECB hawks and doves debate the issue of which mandate is best. The hawks argue for a lower inflation target, and the doves argue for a higher inflation target. Then they pick a target, and at that point they all try to achieve a common goal, the actual target they adopted. There would be differences over purely technical issues, such as what instrument setting would be most likely to hit 1.9% inflation (the ECB’s target.) But that’s all. No one would be consistently hawkish or dovish, at least if their forecasts of future inflation were unbiased. So the fact that people clearly are hawks and doves, suggests that they are either incompetent or corrupt. Add in the fact that the hawk/dove stance is correlated with their views on unrelated issues such as fiscal policy and hard money, and it’s pretty clear that the problem is not just incompetence.
2. You might still be yawning. “So political appointees are not pure as the driven snow. They haven’t really bought into the official target. What else is new? Don’t be so naive.”
Yes, I know all that. But here’s something you may not know. This corruption would be almost impossible under price level targeting. With inflation targeting you can have central banks like the BOJ pretending to be opposed to deflation, but missing their target year after year after year. “We’ll do better next year, I promise.” Jens Weidman seems to have learned from the Japanese:
Mr. Weidmann said he is aware of the risks of too-low inflation. The ECB targets inflation rates just under 2% over the medium term. Annual eurozone inflation was 0.3% in September, a five-year low. However, “the trough of inflation should soon be behind us,” he said.
The fact that 10-year German bond yields have fallen to 0.87% suggests that nobody believes the ECB is going to hit its inflation target. I doubt even Weidmann is that clueless.
With level targeting things would be much different. Suppose the target was set at 1.9% inflation, and we had 0.3% inflation this year. In that case the ECB would have to shoot for 3.5% inflation next year, or 2.7% inflation over the next 2 years, to get back on the 1.9% trend line for the price level. Level targeting keeps central banks honest. It stops them from being dishonest and corrupt. Monetary policy becomes a purely technical exercise, as the debate over the proper long run inflation rate is over. The Greek and German representatives would vote in similar ways. There would be no more conservative hawks or liberal doves, just wise owls.
PS. Obviously I’d prefer level targeting of NGDP, not prices. But even level targeting of prices (more politically acceptable in Europe) would have a dramatic impact on the eurozone, leading to much faster real GDP growth over the next few years.
PPS. This is just one of many reasons why I have no interest in highly technical DSGE models “proving” that this or that policy is “optimal.” These models leave out all the important things in life, such as whether policymaker corruption would be more severe with growth rate or level targeting. Mathematical models “assume a can opener,” i.e. an honest central banker.
PPPS. I was a strong hawk in the 1970s, neutral in the 1990s, and a strong dove since 2008. How many economists can say that?
I will be traveling today, and slow to answer comments.