Ulrich Bindseil, former head of the ECB liquidity management department, debunks ECB monetary policy
from Merijn Knibbe
Wow. The most scathing criticism of the European Central Bank (ECB) money growth target and monetary policy I’ve read thus far is written by Ulrich Bindseil, ECB Deputy Director General of Market Operations and former head of liquidity management, and is published by… the ECB, in 2004. (Hat tip: Jesse Frederik)!
The idea: Central Banks can’t control the supply of money. They can either control interest rates (the price of money) or try to control the quantity of money – which they can’t. And surely not both. See this post for some additional literature. The European Central Bank however still has an official money growth target based upon the idea that the ECB can control the quantity of money, which they explain as follows (a quote from the 2011 “The monetary policy of the ECB” document which is linked on the Home Page of the ECB (p. 55).
“The way in which monetary policy exerts its influence on the economy can be explained as follows. The central bank is the sole issuer of banknotes and bank reserves, i.e. it is the monopoly supplier of the monetary base. By virtue of this monopoly, the central bank is able to influence money market conditions and steer short-term interest rates.”
A view of the world which, according to Bindseil, is nonsensical. He calls this the Reserve Position Doctrine and goes on to state that:
13. The lessons from the rise and fall of RPD
From today’s perspective, the rise and endurance of RPD, a fallacious doctrine on a key concept of monetary policy (the operational target), and its continued popularity in textbooks and some more recent academic work, are rather astonishing. This paper tried to explain the phenomenon of RPD. Academics developed theories detached from realityreality, without resenting or even admitting this
detachment. Economic variables of very different nature were mixed up and precision in the use of the different concepts (e.g. operational versus intermediate targets, short-term vs. long-term interest rates, reserve market quantities vs. monetary aggregates, reserve market shocks vs. shocks in the money demand, etc.) was often too low to allow obtaining applicable results. The dynamics of academic research and the underlying incentive mechanisms seem to have lacked a permanent pressure on monetary economists to investigate the realities of day-to-day work of central banks. From today’s perspective, one could feel that academic economists unconsciously colluded in their distaste for re-questioning the applicability of macro-economic models on day to-day implementation of monetary policy, and their lack of willingness to study the actual features of money markets and monetary policy operations. As Goodhart (2001) puts it: “large parts of macro-economics are insufficiently empirical; assumptions are not tested against facts. Otherwise, how could economists have gone on believing that central banks set H [the monetary base] and not i? In so far as the relevant empirical underpinnings of macro-economics are ignored, undervalued or relatively costly to study, it leaves theory too much at the grasp of fashion, with mathematical elegance and intellectual cleverness being prized above practical relevance.” Unfortunately, it needs to be admitted that the list of RPD inspired papers that contain empirical (econometric) analysis is long. Indeed, most of the more recent papers in the Poole-1970 tradition, as reviewed by Walsh, 2003, fall into this category. Also, a major work in terms of supporting the return to SID, namely Woodford (2003), is primarily of theoretical nature. One may therefore want to conclude that the decline of RPD suggests that empirical analysis (at least in the sense of econometric analysis) is neither sufficient, nor necessary, to correct mistaken avenues in economics. Central bankers failed to resist the reality-detached theories of academics, or even promoted them as they got convinced or as the theories served their aim to mask their responsibility for short term interest rate and thus for economic developments. It is an interesting, but difficult question to disentangle in how far exactly the adoption of RPD as official Fed doctrine on monetary policy implementation was deliberate “play-acting” to mask responsibility, and in how far it was just reflecting convictions. Goodfriend (2003) argues that the denial of responsibility was the dominating factor in the 1920s, and for instance Goodhart (2001) and Mishkin (2004) argue so for the 1979-82 episode. At the same time, there are arguments speaking in favour of the theory that many senior central bank officials believed sincerely into RPD. Originally non-public documents, such as FOMC transcripts of the 1979-82 episode, suggest this interpretation. Also statements as the one reported above from Warburg (1930), who, no longer being in service, was outspoken on the weaknesses of the Fed, while at the same time advocating RPD, seem to support the hypothesis that Fed officials believed at least partially in RPD. More importantly, one needs to admit that the majority of US monetary economists (and e.g. Keynes) were convinced of RPD, without any political economy explanation for that, and if academics were, why should central bank senior officials not have been as well? Of course, central bankers are more directly confronted to reality, but academics could have and often indeed looked at money markets and central bank procedures as well (again, Keynes is an example). If we can imagine academic economists to have been honestly convinced by some theory we believe today to be wrong, the same should probably not be denied to central bankers. In sum, it appears difficult to estimate the general degree of conscious play-acting by central bankers in their supposed RPD practice, probably also since it varied considerably across individuals and time. It seems also noteworthy that both groups, academic economists and central bankers, showed little interest in studying well-documented historical experience (e.g. Bagehot, 1873, King, 1936, Sayers, 1976). Overall, the 20th century thus seemed to have witnessed in the domain of monetary policy implementation a strange symbiosis between academic economists stuck in reality-detached concepts, and central bankers who were open to such concepts, partially since they allowed to avoid explicit responsibility. Masking responsibility seemed to be of particular interest whenever the central bank’s policies were strongly des-inflationary and thus causing recession and unemployment (in the US in 1919-21 and in 1979-82). If one wants to find out how the detour via RPD could have been avoided, it may appear natural to compare again the Fed and the Bank of England in the early 1920s, as the latter easily resisted, but the former did not. While one would probably not want to praise today and wish back the lack of transparency and accountability of the old Bank of England, it seems clear that major weaknesses of the Fed relative to the Bank of England, that we would still name weaknesses today, were its lack of independence, excess decentralisation, and lack of experience. Once the Fed had fallen into the trap of RPD (including a below-market rate discount rate), the experience that it would accumulate was rather opaque, and the likelihood that Bank of England experience would be considered declined more and more as the Fed developed its own traditions. As we want central banks to be accountable and transparent, the main conclusion we have to draw maybe, one more time, the need of central bank independence. If the Fed would have been fully independent from the US Government at least directly after WW1, it would probably have had far less incentives to deny the validity of well established central bank technique, namely that short term interest rates are the operational target of monetary policy.