Session 7: Governance issues

David Archer, Bank for International Settlements

John B Taylor, Stanford University

David Archer said that many central banks may be heading for a legitimacy crisis as they are unable to set or have clear objectives. One reason is that the power and authority held by the central banks has been extended to other areas than those they were originally allocated, in particular with regard to financial stability.

It is unavoidable that the central bank's mandate changes over time, the world sometimes changes very quickly and as political processes take a long time, their mandate must be changed. However, the timing is poor at the moment, as confidence in politics and public authorities is declining in many countries.

Moreover, the low interest rates and foreign currencies in the central banks’ balance sheets mean that their incomes are declining drastically in many countries and this makes them less financially independent.

However, the fact that the mandate changes does not mean that the central banks are actually moving into areas where they do not belong. Ever since central banks were first created, they have played a key role in stable and reliable payment systems.

Four-fifths of the world’s central banks have objectives that concern financial stability, but this refers to the payment system and bank supervision. They are consequently more limited than we are talking about now. Moreover, the objectives are often subordinate, or at least secondary, to the objective of price stability.

The problem with the new objectives concerning financial stability now being discussed is that they are unclear. Very few laws try to define what is meant by financial stability, or what is good or bad, or how much stability is concerned. In addition, the objectives are multidimensional and in many cases contradictory, which means that it is impossible to attain them all at the same time. If one adds such objectives for the central banks, there is an inherent risk that they will fail to attain them, and thereby also lose legitimacy.

John B Taylor also said that the objectives are very important for the central banks’ scope to remain independent. Today's limited and clear price stability objectives, and (in some cases) objectives for employment have considerable value. If the central banks’ tasks are broadened, support for their independence will weaken.

Independent institutions that have several tasks, and are not controlled and governed, are not good in democracies. Consequently, the central banks may lose their independent position if they do not keep their limited purpose.

However, independence is not sufficient. John B Taylor pointed to the major shift to and from rule-based central bank policies that have taken place over time and said that the objectives of the central banks should not be broadened, but rather deepened. A strategy is needed to attain the existing objectives, in which the rules of action for attaining them are clarified. If this is done in many individual countries, it may in turn lead to international monetary agreements.

Given the many calls for reforms of central banks that we are now hearing,     

John B Taylor said that it is also a good time to start introducing more rule-based central bank policies.