«I. Introduction The Institute for Monetary and Economic Studies (IMES) of the Bank of Japan (BOJ) held the 2014 BOJ-IMES Conference, entitled ...»
Based on the BOJ’s experience, Nakaso posed three challenges with respect to forward guidance, control of short-term interest rates, and asset purchases. In terms of the challenge with respect to forward guidance, he explained that the forward guidance currently adopted by the BOJ reﬂected its intention to raise inﬂation expectations and thus could be stronger than the guidance issued by the Fed and the BOE in a situation where inﬂation expectations seemed to be anchored to a certain level. He added that the forward guidance by the BOJ could be seen as containing a holistic judgment in the sense that it included phrases such as “as long as necessary.” In terms of the challenge with respect to control of short-term interest rates, he explained the BOJ’s experience at the time of exit from QE in 2006, when the BOJ had strived to stabilize short-term market rates by conducting ﬁne-tuning of open market operations including both the provision and draining of liquidity. He argued that the Fed might face similar challenges in the forthcoming normalization phase, when it might rely extensively on reverse repos and a term-deposit facility for liquidity draining, which would not guarantee that it could control the upper end of market rates as well as the lower end.
Plosser discussed the role of forward guidance and transparency in inﬂuencing expectations.11 He ﬁrst explained that the stance of monetary policy encompassed not just the current level of the short-term policy rate but also its expected future path, and that expectations about future monetary policy could play an important role in determining the economic outcomes of monetary policy. On top of this, he argued that one of the most important ways to support credibility and thus the eﬀectiveness of forward guidance was to practice it as part of a systematic policy framework, and to be more explicit about a central bank’s reaction function. He commented that one
11. For details, see Plosser (2014).
13 way to be more explicit was to indicate the likely behavior of the policy rate based on a few Taylor-like rules that were consistent with the past conduct of monetary policy and robust to uncertainties regarding economic models. He added that the principles of a systemic policy framework applied equally well to balance-sheet policies, arguing that the signals conveyed by such policies should be consistent with forward guidance on future interest rate policies. In this regard, he mentioned that the use of particular economic models, including the FRB/US model, seemed to be a reasonable starting point for providing economic forecasts based on the policy rules. He concluded that steps toward greater transparency and communication would mark signiﬁcant progress and encourage the Fed to conduct policy in a more systematic manner.
Rajan discussed two concerns about the protracted accommodative monetary policy in advanced countries.12 First, he pointed out that the policy did not seem to create domestic demand so much because of debt overhang, structural problems, or fundamentally weak demand, while it seemed to shift demand away from other countries through cross-border capital ﬂows and currency depreciation. In the meantime, some distortion might occur and leverage risks might build up in the ﬁnancial sector under the condition that tremendous liquidity prevailed there and the world interest rate was set very low. In such an environment where people ﬂocked into risky assets, transparency in central banks’ policies might create a rather diﬃcult situation in the process of exiting from the accommodative monetary policy. Second, he argued that the spillover eﬀects of accommodative monetary policy might create much stronger demand in other countries than they wanted, inducing them to take additional monetary policy actions and eventually driving the world economy into a situation that was suboptimal. On the other hand, it was diﬃcult for central banks to take account of the spillovers and other countries’ policy reactions over time as long as they focused on their domestic mandates. Against this concern, he pointed out that the Precautionary and Liquidity Line of the IMF could be more helpful in oﬀsetting a reversion to reserve accumulation as a way to build safety nets if it could be converted from a pull line—which could make countries fear the stigma of coming under the supervision of the IMF—to a push line, to which countries were given access without necessarily asking for it. He also stated that stronger international safety nets including multilateral swaps were worth exploring as a starting point for collective monetary policy cooperation.
From the viewpoint of a need for the legitimacy of central bank independence to be underpinned, Tucker discussed macroprudential policy and balance-sheet policy.13 As for macroprudential policy, he argued that it should be used to keep the resilience of the banking system constant even when economic conditions were changing; an equity requirement of, say, 10 percent did not provide the desired degree of system resilience if the world became riskier than when the regulatory regime was calibrated. He added that stress testing conducted by central banks enabled them to engage in debate with the legislature and the public about the degree of resilience they desired in the banking system, thus contributing to ensuring the credibility and legitimacy of central banks.
Second, he pointed out that the ﬁnancial system was essentially a shape-shifter in the
12. For details, see Rajan (2014).
13. For details, see Tucker (2014).
sense that the ﬁnancial system adapted to rule-based regulation. There was a distinct possibility that the substance of banking would move outside de jure, regulated banks.
He also observed that some nonbanks such as securities dealers had the economic substance of banks through their prime brokerage business, exposing central banks to risk of having to provide liquidity assistance. As for balance-sheet policy, he argued that when central banks conducted QE policy in government bonds, cooperating with the government was essential in order to avoid government debt managers oﬀsetting the economic eﬀects and to recognize the ﬁnancial risk entailed. As an example, he mentioned that the BOE and the U.K. government agreed on both: the government would indemnify the BOE for any loss and would keep debt management strategy unchanged.
Bizarrely, in the United States the treasury had extended the maturity of its debt. In this regard, he added that central banks needed to accept that their policy overlapped with ﬁscal policy, but that that could be harmless as long as there was a clear ‘ﬁscal carveout,’ so that elected politicians blessed the high-level regime and the public could see what happened when central banks made proﬁts or incurred losses on their balance sheet.
B. General Discussions Following the panelists’ remarks, Obstfeld commented on a few issues relevant for central banks’ policies in a post-crisis era. First, he pointed out that the recent crisis had shown that an optimal monetary policy did not necessarily guarantee that the ﬁnancial sector would be robust and resilient. On top of this, he stated that monetary policy and macroprudential policy were inherently interrelated, for example, in that protracted accommodative monetary policies might create incentives which impaired ﬁnancial stability. Second, he pointed out that the crisis had also shown the importance of global policy cooperation, because macroprudential policy on a stand-alone basis might be ineﬀective in globally integrated ﬁnancial markets.
In response to Obstfeld’s comments, Mersch discussed the prudential policy in Europe after the crisis. He ﬁrst emphasized that the ECB was striving to preserve the integrity of the single currency and thus retain a single economic and monetary union. Then he mentioned that one of the policy priorities in Europe was to restore the conﬁdence in the banking system, and that the banking union had been established to achieve this policy priority with a focus on microprudential policy rather than macroprudential policy. As for the macroprudential approaches in Japan, Nakaso explained that the Financial Services Agency (FSA) was the primary regulator in a position to conduct macroprudential policy. He added that because the BOJ had better access to the market, it could provide the FSA with an assessment of systemic conditions in the market, which was one of its key roles in macroprudential policy. Tucker explained that central banks could not help becoming involved in many macroprudential areas such as supervisory policy, regulatory policy, and thus credit policy, as long as the central bank was the monopoly issuer of the ﬁnal settlement asset, i.e., ﬁat money, as that made it the ﬁnal provider of liquidity. Lender-of-last-resort operations were risky interventions in the credit system and so the central bank had to be involved in banking policy and surveillance of its soundness. Goodfriend mentioned the problem of 15 excessively low minimum capital standards due to competitive international subsidization and asked if this problem had been resolved. Anne Le Lorier (Banque de France) raised a question as to whether central banks should embark on regulating nonbank entities and controlling them.
Regarding the mandate and accountability of central banks, Jordan agreed with Tucker’s views on the importance of a cooperative relationship between a government and a central bank, and added that central banks’ mandates should be as clear as possible and that they should remain time-consistent. He also emphasized that central banks’ policy frameworks should be simple allowing them to concentrate on their mandates without too much ﬁne-tuning. Plosser noted that central banks should not be accountable for things they cannot control. He pointed out that central banks would put their independence at risk if they ventured into policies that were not explicitly within their own domain. In addition, he stated that it was important for central banks to conduct policy in a systematic and predictable way by maintaining transparency in their communications, which helped to preserve their independence. Ito commented that he was struck by the contrast between Plosser and Tucker in the distance between the government and the central bank. He wondered whether this contrast derived from the unique fact that a central bank had been abolished twice in U.S. history, whereas it had not been abolished in the United Kingdom, Japan, or elsewhere.
Berk asked the panelists what the future of central bank independence looked like given the conﬂuence between monetary and ﬁscal policies after the crisis. Jordan replied that it would depend on central banks’ performance over the next few years in terms of ﬁnancial stability as well as price stability, including a successful exit from unconventional monetary policy. He mentioned that, in order to avoid putting independence at risk, it was important to deliver on price stability by not only avoiding deﬂation but also avoiding inﬂation in the exit policy phase. He also stated that it was incorrect to think that monetary policy did not have any distributional eﬀects, and therefore it was important to achieve price stability in the medium and long term. Mersch commented that during the crisis central banks’ mandates had broadened in comparison with the time independence had been given to central banks, and that inevitably the central banks had to adjust their accountability and transparency so that no question occurred concerning their independence. Rajan expressed a concern that monetary policy was relied on too heavily when other policies did not work well. As a result, he argued that the global economy could become sub-optimal when major central banks took an unconventional set of policy actions. In addition to these panelists’ comments, Lipton emphasized the importance of central banks’ belief and credibility in achieving their mandates, and stated that they should not doubt their ability to achieve their mandates. On the other hand, Végh illustrated that central banks tended to allow the market to think that monetary policy was much more powerful than actually it was.
Wynne raised a question as to what compelled central banks to try to conduct so many policies.
Regarding the exit policy from QE and forward guidance, Nakaso claimed that the true test for the eﬀectiveness of forward guidance was still to come, in the sense that it should be tested whether forward guidance compressed the level and volatility of expected short-term rates even when markets expected an exit from the zero interest 16 MONETARY AND ECONOMIC STUDIES / NOVEMBER 2014 Monetary Policy in a Post-Financial Crisis Era rate policy was approaching. On the possibility of overreaction in the ﬁnancial markets during the exit process, Tucker said that policymakers should not be overly concerned about short bursts of volatility. Smoothing volatility could easily lead to excessive risk-taking, so policy could have perverse eﬀects. Policy should systematically feedback from the outlook for inﬂation given an unavoidably highly uncertain assessment of the balance of aggregate demand and supply. In that familiar setup, withdrawing some of the extraordinary monetary accommodation would be quite normal. His suggestion was based on his recognition that the ﬁnancial markets always second-guessed central banks’ actions in the search for proﬁt, but that their behavior might have only short-run eﬀects on volatility because of the lack of attention given to fundamentals.