Central banks should do their job
The title of this post sounds like a truism, and yet it’s actually highly controversial. In my previous post I pointed out that the ECB was not hitting its 1.9% inflation target, and apparently has no plan for doing so in the future.
In a new article, William Pesek recommends that the Bank of Japan stop doing its job, as a way of pressuring Prime Minister Abe to enact the BOJ’s preferred policy agenda, in areas unrelated to monetary policy.
Analysts are expecting a rush of new fiscal stimulus early in the new year. Kuroda, too, will face pressure to one-up himself when the BOJ meets on Friday. Like addicts looking for their next fix, markets want the central bank governor to outdo his “shock-and-awe” from April 2013 and recent Halloween surprise on Oct. 31, when he boosted bond purchases to about $700 billion annually.
It’s time for Kuroda to do exactly the opposite: hold his fire and prod Abe to begin doing his part to push through his “third arrow” structural reforms. To this point, Kuroda has been a dutiful and circumspect policymaker — perhaps to a fault. Other than a brief flash of impatience with Abe’s foot-dragging in a May Wall Street Journal interview — when he said “implementation is key, and implementation should be swift” — Kuroda has held his tongue. Yet he bears a responsibility to play the honest broker role that monetary powers have over the years — from Paul Volcker at the Federal Reserve decades ago to Raghuram Rajan at the Reserve Bank of India today.
On Friday, Kuroda should tell reporters, “Now that the election is over, it’s up to Prime Minister Abe to carry out the will of the people and deregulate the economy. For now, we at the BOJ have done all we can — and are willing to do — to make Abenomics a success.”
Kuroda’s mandate is not to “make Abenomics a success,” it is to hit a 2% inflation target, and thus far he has fallen short of that goal. The target is probably not optimal, but economies do better when central banks follow a consistent and predictable monetary regime. There are two problems with encouraging central banks to miss their targets:
1. It undercuts democracy and transparency. Political regimes work best when each part of the government has clearly defined tasks, and is held accountable for achieving its policy goals. The monetary authority should do monetary policy, and the Japanese government should do fiscal policy and structural reforms.
2. Yes, it’s theoretically possible that damaging the Japanese economy through excessively tight money will lead to even greater gains elsewhere, if it encourages structural reforms. But the downside risks are much greater. History is littered with cases where failed monetary policy led to harmful economic changes (the NIRA in 1933, or Argentinian moves toward statism after 2002.) And of course there are cases where bad monetary policy led to disastrous political changes, notably the German deflation of 1929-32, which led directly to a Nazi government.
It’s simply too risky to intentionally damage an economy in one area in the hope that it pressures a different part of the government to adopt better polices in another area. Central banks need to follow a clear and transparent policy rule, and let other parts of the government address other issues. Central banks should do their job.