Central Bank Governance and Oversight Reform, edited by John H. Cochrane and John B. Taylor

8/17/2019 Central Bank Governance and Oversight Reform, edited by John H. Cochrane and John B. Taylor

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Central Bank Governance

and Oversight Reform

Copyright © 2016 by the Board of Trustees of the Leland Stanford Junior University. All rights reserved.


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Te Hoover Institution grate ully acknowledgesthe ollowing individuals and oundations

or their signi cant support o theWorking Group on Economic Policy and this publication:

Lynde and Harry Bradley Foundation

Preston and Carolyn Butcher

Stephen and Sarah Page Herrick

Michael and Rosalind Keiser

Koret Foundation

William E. Simon Foundation

John A. Gunn and Cynthia Fry Gunn



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Central Bank Governanceand Oversight Reform

EDITED BY

John H. CochraneJohn B. Taylor

CONTRIBUTING AUTHORS

Michael D. BordoAlex Nikolsko-RzhevskyyDavid H. PapellCharles I. Plosser Ruxandra ProdanGeorge P. ShultzPaul Tucker Carl E. WalshKevin M. Warsh

John C. Williams

HOOVER INSTITUTION PRESSSTANFORD UNIVERSITY STANFORD , CALIFORNIA



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Contents

Pre ace vii John H. Cochrane and John B. aylor

ONE How Can Central Banks Deliver CredibleCommitment and Be “Emergency Institutions”? 1Paul ucker

Comments: John H. CochraneGeneral Discussion: Michael D. Bordo, John H. Cochrane,Peter Fisher, Robert Hodrick, Charles I. Plosser, George P.Shultz, John B. aylor, Paul ucker, Kevin M. Warsh

TWO Policy Rule Legislation in Practice 55David H. Papell, Alex Nikolsko-Rzhevskyy and Ruxandra Prodan

Comments: Michael Dotsey General Discussion: John H. Cochrane, Michael Dotsey,Peter Fisher, Andrew Levin, David H. Papell, Charle I. Plosser, John B. aylor, Paul ucker, Carl E. Walsh, John C. Williams

THREE Goals versus Rules as Central BankPerformance Measures 109Carl E. Walsh

Comments: Andrew LevinGeneral Discussion: John H. Cochrane, Michael Dotsey,David H. Papell, John B. aylor, Carl E. Walsh, John C.Williams



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FOUR Institutional Design: Deliberations, Decisions,and Committee Dynamics 173

Kevin M. WarshComments: Peter Fisher General Discussion: Binyamin Appelbaum, Michael D. Bordo, John H. Cochrane, Michael Dotsey, Peter Fisher, Andrew Levin,Charles I. Plosser, George P. Shultz, Paul ucker, Kevin M.Warsh, John C. Williams

FIVE Some Historical Reections on the Governance

of the Federal Reserve221

Michael D. BordoComments: Mary H. Karr General Discussion: Michael D. Bordo, John H. Cochrane,Peter Fisher, Mary H. Karr, Andrew Levin, Charles I. Plosser,George P. Shultz, John B. aylor, Paul ucker, Kevin M. Warsh, John C. Williams

SIX Panel on Independence, Accountability, andTransparency in Central Bank Governance 255Charles I. Plosser, George P. Shultz, and John C. Williams

General Discussion: Michael J. Boskin, John H. Cochrane,Peter Fisher, Robert Hodrick, Andrew Levin, David Papell,Charles I. Plosser, John B. aylor, Paul ucker, Kevin M. Warsh, John C. Williams

Con erence Agenda 297About the Contributors 299

About the Hoover Institution’s Working Group onEconomic Policy 305

Index 309



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Preface John H. Cochrane and John B. aylor

At the time we were organizing this con erence, most o the volu-minous commentary about the Federal Reserve System centeredon what decisions it should take. Should the Fed raise interestrates? How soon? How much?

We thought the con erence could make more progress by ocus-ing on a different and deeper set o questions. How should the Fed

make decisions? How should the Fed govern its internal decision-making processes? How should Congress, rom which the Fedultimately receives its authority, oversee the Fed? Central bankindependence is a great virtue, but independence in a democracymust come with clear limits and a limited scope o action. Whatshould those limits be? What is the trade-off between greater Fedpower and less Fed independence? How should Congress man-

age its undamental oversight role? Several bills in Congress stipu-late more rules-based policy and consequent accountability, alongwith deeper monetary re orms. Are these bills a good idea? Howshould they be structured?

Te distinguished scholars and policymakers at the con erence,whose contributions and commentary are represented in this con-

erence volume, do not disappoint in their analysis o these andrelated questions.

Paul ucker’s opening paper, “How Can Central Banks DeliverCredible Commitment and be ‘Emergency Institutions’?” leads offwith a central conundrum: in general, people seem to want central



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banks to ollow rule-based policy in normal times, but peopleexpect banks to take a much more discretionary do-what-it-takes

approach to stopping nancial crises. ucker asks i these two hatscan be worn at once. He builds up to the basic conclusion: “LOLR[lender o last resort] liquidity reinsurance policy can be system-atic, and should be ramed within a regime,” just as normal-timesmonetary policy should be so ramed.

ucker starts by thinking through the limits on the central bank’stools. Should the central bank, even in a crisis, be legally limited totraditional open market operations, exchanging reserves or short-term treasuries? Or should the central bank be ree to purchasemany different kinds o assets in crises? He notes the many restric-tions, including central bank independence, that stand in the wayo in ationary nance in normal times, but which may be inap-propriate during crises.

Looking at the modern nancial system, ucker concludes thatmoney, credit, and nance are not separable. He advocates an inte-grated money-credit constitution consisting o “in ation targetingplus a reserves requirement that increased with a bank’s leverageplus a liquidity-reinsurance regime plus a resolution regime orbankrupt banks plus constraints on how the central bank is ree topursue its mandate.”

ucker goes on to think about what constraints and gover-nance should apply to the central banks’ lender-o -last-resortand liquidity-reinsurance unctions. He starts by noting thecurrent status: “nearly all central banks . . . stand ready to lendagainst a wide variety o collateral, including port olios o illiquidloans . . .” More contentious is whether central banks should “lendto non-banks or . . . act as a market-maker o last resort.”

In this situation, bankers ace large moral hazard and pre- commitment problems. ucker points out that received wisdomsays they should lend only to illiquid—not insolvent— rms, but inpractice the two are hard to distinguish. He argues there ore that



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Preface ix

a “regime” is desirable vs. untrammeled discretion, and legislativeconstraints can overcome the large pre-commitment problem.

ucker rames the issue within the broader question o what“emergency powers” are appropriate or any government. In prac-tical terms, he approves o arrangements, such as in the Dodd-Frank Act, that allow the Fed to innovate beyond its customaryor legislatively limited powers, afer getting permission rom thepresident and secretary o the treasury, a view echoed in slightlydifferent orm later in the con erence by Charles Plosser.

ucker goes on to consider the question o whether the cen-tral bank should be able to exceed its limits in perceived economic(rather than nancial) emergencies—by, or example, buyingstocks, mortgages, or government-guaranteed mortgage-backedsecurities in order to stimulate demand, as the Fed did—againconcluding that some sort o regime is needed.

John Cochrane’s discussion cheers the basic conclusion: untram-meled discretion in crises leads to unlimited moral hazard in thepreceding boom. Cochrane emphasizes the pre-commitmentproblem, that “sel -imposed rules, promises, guidance, and tradi-tion are not enough.” In the crisis, central bankers will bail outinstitutions and their creditors, support prices, and lend i they can;knowing that act, people will take risks and ail to keep enough

cash around, making the crisis worse and orcing the bankers tocave. Only legally binding limitations can stop the cycle.

Cochrane takes a dimmer view o current institutions in ul ll-ing ucker’s vision, opining that there is very little current con-straint on central bank actions. He also criticizes the traditionalBagehot rules. Who cares i an institution is illiquid vs. insolvent?Te central bank is not there to be a pro table hedge und—it’sthere to save the economy. Tere is little obvious link between sys-temic danger (whatever that is) and the liquidity vs. solvency line.

Responding to ucker’s call or yet more thinking and researchto make the current money-credit constitution work, Cochrane



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opines that an equity- nanced banking system is a much morepromising alternative to endless research.

A written record o the general discussion o ucker’s paper ol-lows, with George Shultz’s summary o the nancial crisis beingthe highlight.

As with all o the general discussions throughout this book, thecommentary is based on a recording made at the con erence, romwhich a transcript was created. Participants then edited their com-ments or clarity ollowing the con erence.

Te next paper, “Policy Rule Legislation in Practice,” was pre-sented at the con erence by David Papell and is coauthored withAlex Nikolsko-Rzhevskyy and Ruxandra Prodan.

Te paper care ully evaluates legislation, recently proposed inthe US House and Senate, which would require the Fed to describeits monetary policy rule and, i and when the Fed changed or

deviated rom its rule, explain the reasons. Te paper applies or-mal econometric methods to these legislative proposals. Papell,Nikolsko-Rzhevskyy, and Prodan consider several versions o the

aylor rule to see how ofen in the past monetary policy deviatedrom that rule, and thereby assess how ofen the Fed would have

had to explain deviations rom its own rule to Congress under theproposed legislation. Teir analysis care ully uses real-time data,

adheres to the data de nitions in use historically, and offers severalplausible variations.

All o the versions o the aylor rule examined in the paper pro-duce extended periods o substantial deviation, including the sin ation (they nd that policy was loose), the Volcker disin ation(they nd that policy was tight), and in the early s and s.So, i the legislation had been in place starting in the early s, ithe Fed had chosen the aylor rule back then, and i the legislationhad not induced the Fed to alter its policy, the Fed would have hadeither to announce a new rule or to explain its deviations or sub-stantial periods in the s, early s, and more recently.



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Preface xi

Michael Dotsey leads a sharp discussion. Tough the broadbrush o when the Fed was in compliance with the rule is airly

robust, Dotsey notes that “how one measures the output gap, andwhich in ation rate is used in the rule” matter to whether the Fedis in compliance or not.

Te biggest issue Dotsey raises is the difference between the ay-lor rule with no lags which aylor originally proposed (describedas a re erence rule in the proposed legislation), in which the undsrate depends on output and in ation only, and estimated aylorrules that include the lagged unds rate and (less important quan-titatively) lagged responses to in ation and output gaps. With lags,we obtain a very good t throughout postwar history: “It is rareto nd discrepancies greater than twenty basis points . . . ” Dotseyadds that much theoretical literature recommends rules with iner-tial responses, i.e., lagged unds rates on the right-hand side.

A long and thought ul general discussion o these ideas ollows.Which kind o rule should be used: an “inertial” rule with lags ora simpler rule without lags? Te inertial rule ts the data better,but largely says that the Fed should continue doing whatever itwas doing, even i that was a mistake. It also ts so well that theFed would likely never be in violation. Should a rule t the datawell, or is the whole point o legislation in act to constrain the Fed

to do things differently in the uture than it has at some times inthe past? I there are to be long-lasting deviations rom the rule,should Congress get used to routine “explanations” o deviations

rom a rule? Or will the Fed just announce new “rules”?John aylor concludes the discussion, answering many o these

questions by emphasizing that the bills envision the rule as a “strat-egy,” not necessarily a mechanical ormula. It would be the Fed’s job to de ne and communicate its goals along with the strategy toachieve the goals.

Carl Walsh’s contribution considers “Goals versus Rules as Cen-tral Bank Per ormance Measures.”



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Walsh takes on an issue that pervades much o the discussionin this book: I Congress holds the central bank to a rule, should

it be an instrument rule, such as an interest rate rule, telling theFed how to act? Or should it be a goal, such as an in ation target,setting a narrow objective or the central bank and accountability

or that objective, but leaving the bank great discretion in how toachieve the objective?

Te heart o Walsh’s paper is an evaluation o goal-based vs.instrument-based rules in a simple model. Walsh assumes that thesocial wel are unction is a weighted sum o squared deviations ooutput and in ation. Te central bank’s objective, however, addsshocks, so it tries to minimize the weighted sum o output andin ation rom these shocked values. Te shocks represent tempo-rary political pressures to deviate rom the regular rule. Te econ-omy ollows a standard new-Keynesian intertemporal substitution

relation, in which output depends on expected uture output andthe real interest rate, and a standard new-Keynesian orward-look-ing Phillips curve.

In this setting, Walsh is able analytically to characterize thesocial wel are o the resulting equilibrium. He models a rule as anadditional term in the central bank’s objective that prizes devia-tions rom an in ation target or deviations o the unds rate rom

the recommended rule.So which is better? Walsh nds that, in general, an optimal

combination includes both an in ation target and a rule. Te rela-tive weight depends on the variances o shocks: cost shocks raisethe weight on a rule, but demand shocks raise the weight on anin ation target.

In a more complex calibrated model, Walsh nds that “the de -nition o real activity used in the rule is crucial.” A rule based onoutput deviations rom potential receives no weight relative to anin ation target. But a rule based on the gap between output and itseffi cient level gets weight along with an in ation target.



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Preface xiii

Naturally, the comments and discussion about Walsh’s analysisrage over just how to interpret these results, and which eatures o

the rule vs. goal debate the model captures.Andrew Levin, the lead discussant, notes that the model has

i.i.d. shocks, considers only the discretionary solution (i.e., the Fedcannot commit to policies), and has no learning.

Levin points out that in this model the Fed can per ectly off-set aggregate demand shocks but not aggregate supply shocks. Ashe explains, the in ation target is imper ect—it orces the centralbank away rom its pre erence shocks, but only toward desirablein ation, not output. He wonders whether adding an output targetas well would restore this balance. Analytically, adding huge coststo deviations rom in ation and output, the government could, inthis model, make the central bank’s objective equal to the socialobjective.

Similarly, Levin points out that the aylor rule is imper ect herebecause the central bank can no longer respond to natural rateor aggregate demand shocks. Well, since these are observable inthe model, why not just add them to the rule? Te problem withmodels is that there is always an optimal policy, and then one mustthink why a simple rule is not just the optimal policy.

Levin continues to say that a large unction o the rule is to

communicate what the Fed is doing. Tis communication role ismissed in the paper.

Next, Kevin Warsh presents “Institution Design: Deliberations,Decisions, and Committee Dynamics.” He ocuses on the eternally vexing question: How do you best structure a committee—like theFederal Open Market Committee, which sets interest rates—tomake good decisions?

Warsh reviews a lengthy, interesting, and, to economists, largelyunknown literature on committee decisions, especially how to os-ter a genuine deliberation and how to balance inquiry vs. advo-cacy. Anyone running a aculty meeting, take note.



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Warsh then summarizes his conclusions rom a comparisono the UK Monetary Policy Committee (MPC), which he was

invited to evaluate, and the US Federal Open Market Committee(FOMC).

In Warsh’s view, the MPC is set up in a way that is “ avorable togenuine deliberation and sound decision-making.” It is small anddiverse. “Individual contributions can be identi ed and evaluated,and its members are encouraged to think or themselves.”

Te rst day o an MPC meeting has a ree- owing and opendebate, with healthy listening, deliberation, and changing ominds. Te second day moves to “advocacy,” in which memberstry to convince each other o the conclusions they have reached.

By contrast, the FOMC suffers “certain institutional aspects . . .which differ somewhat rom best practice . . . ” Te FOMC is muchlarger: nineteen people convene in the discussion, with about sixty

people in the room. Dissents are rare and the chair never loses a vote, in contrast with the UK, in which votes are seldom unani-mous and the chair ofen loses.

Public transcripts, while seemingly use ul or transparency, mayhave the unintended effect that “FOMC participants . . . voice lessdissent in the meetings themselves, and [are] less willing to changepolicy positions over time.” Te Sunshine Act means that the “real”

discussions happen in small groups centered around the chair. Teresulting meetings consist o members giving care ully preparedset-piece speeches, in ull advocacy mode rom the start, and thereis little true deliberation.

Peter Fisher, the lead discussant o Warsh’s paper, stresses individual vs. group accountability, which covers many issues raised inthe general discussion. As Fisher puts it, “I thought I understoodthe awkwardness o group accountability when more than onceI saw the FOMC gravitate toward no one’s rst choice and virtu-ally no one’s second choice, and we ended up with third-best out-comes. But now I’m also worried about individual accountability



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Preface xv

o a pseudo-nature [speeches or the FOMC record], which I’ma raid is the regime we now have.”

Fisher stresses that “effective decision-making bodies tend topractice individual input but collective accountability . . .” Afer the vote, people don’t stress their dissents. He believes that we don’thave that now. “Te single most important output o monetarypolicy is the expected path o short-term interest rates, and yet thecurrent FOMC eels ree to allow every man and woman to havetheir own expected path.”

Next is Michael Bordo’s paper, “Some Historical Re ections on theGovernance o the Federal Reserve.” Te Federal Reserve has a com-plex structure which has evolved through history. Te United Stateshas long distrusted a national central bank, appointed by the centralgovernment and close to the nancial center, as is the case in manyother countries. So the Fed in started with a degree o autonomy

o the regional banks that is surprising even by today’s standards.Furthermore, regional banks were owned by member banks andtheir governors were appointed by local directors. In the early years,regional banks actually conducted “their own monetary policies toin uence economic conditions in their own districts.” Bordo recountsmany instances o regional vs. Board o Governors con ict.

Bordo then chronicles the shif o power rom Reserve Banks

to the Board o Governors. Most recently, the nancial crisis wasmanaged by the Board and the New York Fed, and the Dodd-FrankAct gives the Board great power as part o the Financial StabilityOversight Council. It also weakens the power o local boards toselect regional bank chairs.

Bordo ocuses on a major controversy, central to the theme othis book: Were the Federal Reserve’s many ailures primarily dueto its governance structure or to mistakes in its understanding ohow monetary policy works?

Bordo also recounts some o the history in which regionalbanks played important roles in developing new ideas, outside the



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Washington–New York axis o power and occasional groupthink.In particular, he cites the monetarist in uence rom St. Louis in the

s and the recent concerns by regional presidents—includingJeffrey Lacker o Richmond, Charles Plosser o Philadelphia,Tomas Hoenig o Kansas City, and Richard Fisher o Dallas—overthe use o credit policy, bailouts, and large-scale asset purchases.

Bordo concludes that “the ederal/regional nature o the Fed isone o its great sources o strength” and that the “ ederal/regionalstructure . . . should be preserved.”

Mary Karr’s lead discussion emphasizes the question o “howbest to retain independent voices.” She warns that “structural reor-ganization” usually means “some urther centralization o authorityin Washington.” She also emphasizes the deep question o whetherthe Fed’s mistakes were “structural de ects or mistakes in theory.”She argues against the “myth that bankers control the Fed and the

Fed was created by—and to bene t—bankers,” while explainingthe “complex scheme or the selection o Reserve Bank directors.”A long, insight ul discussion on the value o the regional bank

structure ollows.Te con erence volume closes with a “Panel on Independence,

Accountability, and ransparency in Central Bank Governance”with Charles Plosser, George Shultz, and John Williams. Charles

Plosser leads off. He rst reminds us how important it is to havea “healthy degree o separation between government offi cials whoare in charge o spending and those who are in charge o printingthe money,” which is the most essential part o good governance.He emphasizes that recent criticisms and the moves in Congressto rethink Fed governance are natural given how much the “Fedhas pushed the envelope o traditional monetary policy,” includingbailouts, six years o zero interest rates, aggressive asset purchases,and purchases o mortgage-backed securities which constitute acredit allocation policy, properly part o scal policy.



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So how can we balance authority, including independence, withaccountability and constraints? Plosser argues, rst, that the man-

date should be narrower. He advocates price stability as the onlymandate. Second, the Fed should be restricted in the type o assetsit can buy or sell. And third, a more transparent communication omonetary policy strategy, “where rules can play a vital role,” wouldhelp to ensure discipline and accountability.

Plosser thinks the public “has come to expect way too muchrom central banks” to solve “all manner o economic ills.” In the

end, the demand or constraints on Fed action must derive romthe public and be represented in Congress.

Regarding Paul ucker’s conundrum—whether lender o lastresort should be less limited and more discretionary—Plosser sug-gests that emergency lending and bailouts really are scal policy.Tere ore, there should be a new accord between the reasury and

the Fed. Te reasury takes the responsibility or bailouts or assetpurchases to enhance nancial stability (rue ully noting, “howeverthey want to de ne that term”). But the reasury then asks the Fedto execute the policy.

George Shultz next reminds us that we need to restore a compe-tent government, and trust in that competence. Limiting the pur-poses o an organization is a key to competence.

He sounds a warning against the siren song o transparency,noting that “the Fed speaks with about a dozen voices . . . peoplesound off all the time, and it’s a little hard to gure out just whatis the policy.” Bottom line: the Fed, like ed Williams (or eddyRoosevelt) should talk less. Tis is a deep comment in an era whenthe Fed, under “ orward guidance” and at the zero bound, doesreally little else than talk.

But Shultz reminds us that the administration must support Fedindependence. Reagan supported the Fed’s anti-in ation efforts,whereas other presidents undermined the Fed.



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Last, but certainly not least, John Williams writes about the“independence dilemma,” touching on many themes o the

con erence.He describes the day’s dilemma thus: “Success ul monetary pol-

icy necessitates both an arm’s-length relationship to the politicalprocess and oversight by elected offi cials.” Williams reminds us o“operational mandates” o the gold standard, xed exchange rates,and money growth rules. Each neatly solved the governance prob-lem, but each turned out to produce troubled monetary policyregimes. He contrasts these regimes with “goal mandates” in whichthe government tells the central bank what it wants to achieve, suchas an in ation target, but leaves the bank ree to achieve it withmuch less constraints on the nature and use o tools. He remindsus o the general success o in ation targeting.

Williams closes, however, in avor o a “monetary policy rule

such as the aylor rule.” Such a rule includes goals—such as thetarget percent in ation rate—but also speci es in general termshow the Fed should move its lever, the short-term interest rate, toachieve those goals.

He raises three important issues, however: how to handle varia-tion in the “natural rate” o interest, which is an input to aylorrules, in a less judgmental and discretionary way; and the lesser

issues o the zero bound and just which rule should be ollowed.George Shultz concludes the general discussion and the whole

con erence with “Welcome to Cali ornia,” wry in context but surelyexpressing how the participants in this con erence elt at the end othe long day o ascinating and novel discussion.



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CHAPTER ONE

How Can Central Banks DeliverCredible Commitment and Be“Emergency Institutions”?

Paul ucker

Central banks per orm two apparently quite different unctions.On the one hand, they are expected to operate monetary policy ina systematic manner in order to smooth uctuations in economicactivity without jeopardizing the economy’s nominal anchor. Onthe other hand, in their role as the lender o last resort, they areexpected to operate with the exibilityo the economy’s equivalent

o the US cavalry.Both those propositions invite dissent and are unquestionablycontested. On monetary policy, there are those, perhaps not herein Stan ord, who will want to shout that monetary policy cannotbe tied to rules but must be ree to meet circumstances that arehard to athom in advance. On lender-o -last-resort (LOLR) pol-icy, meanwhile, there are those who stress with no less vehemence

that a more rule-like regime is needed in order to keep centralbanks rom straying too ar into scal territory: liquidity supportshould be distinct rom a solvency bailout.

Nevertheless, I suggest that the dominant views are as I initiallyexpressed them, and not without reason.

Society gives the monetary reins to unelected technocrats inorder to mitigate problems o credible commitment. A neces-sary precondition or delivering on that promise is that policy be

My thanks or exchanges on various o the issues covered here to Alberto Alesina, EricBeerbohm, Steve Cecchetti, Anil Kashyap, Athanasios Orphanides, Philip Pettit, JeremyStein, Adrian Vermeule, and Luigi Zingales.



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2 Paul Tucker

systematic. Big picture, this is an institution designed or normalcircumstances. Having, separately, allowed ractional-reserve bank-

ing, society also wants the monetary authority to provide liquidityre-insurance to banks in order to protect it rom the social costsconsequent upon the private banking system’s liquidity-insuranceservices being abruptly withdrawn. Tat, by contrast with regu-lar monetary policy, is an institution or economic and nancialemergencies.

I a central bank succeeds in building a reputation or operatinga systematic monetary policy, is that reputation jeopardized whenit reveals its normally hidden innovative side during a crisis? Con- versely, might a reputation or rule-like behavior in normal timessap con dence in its ability to ride to the rescue in a crisis? In otherwords, do central banks need to sustain a rich, multipurpose repu-tation that aces in two directions?

Tat is the subject o these remarks. Note that my title is not“Can central banks deliver credible commitment and be ‘emer-gency institutions’?” It is “How can central banks [do so]?” Inother words, I am positing that there is no choice other than tohouse these two unctions, two missions, in a single institutionand, urther, one that is highly insulated rom day-to-day politics:an independent central bank.

It is striking, there ore, that debates about the design omonetary-policy regimes and, when they have occurred at all,debates about the LOLR’s role in crisis management have largelyexisted in parallel universes. Te silos might be com ortable, butthey hardly help society design and oversee the central banks intowhich they have placed so much trust.

Signs o this are apparent in current debates about the FederalReserve and its advanced-economy peers. Te “Audit the Fed”and “ aylor Rule” bills in Congress are ramed as being aboutmonetary policy, which o course they are. Quite separately, theDodd-Frank Act materially changed the scope and autonomy o



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How Can Central Banks Deliver Credible Commitment? 3

the Fed as a lender o last resort, and resh proposals have recentlybeen launched in the Senate. My point here is not on the merits or

demerits o those or any other substantive provisions, nor is it thatall re orms should come via a single piece o jumbo legislation.Rather, the point is that we might do better to think about centralbank unctions in the round, in terms o one joined-up regime orpreserving monetary stability broadly de ned .

I that is right, we need to step back a bit to think more care ullyabout what we are dealing with here. As I attempt to do so, we shallbump into some airly deep questions about the distribution opower in democracies. We will also see the monetary policy/LOLRdichotomy dissolve, but only or it to be replaced by a deeper chal-lenge or the design o robust, legitimate central banks: how toproceed when the scal constitution is not pinned down.

What do central banks do? Delegated managersof the consolidated state balance sheet

One way into this is to think o the central bank as conductingnancial operations that change the liability structure and, poten-

tially, the asset structure o the consolidated balance sheet o thestate. I they buy (or lend against) only government paper, the

consolidated balance sheet’s liability structure is altered. I theypurchase or lend against private-sector paper, the state’s balancesheet is enlarged, its asset port olio changed, and its risk expo-sures affected. Net losses ow to the central treasury in the orm oreduced seigniorage income, entailing either higher taxes or lowerspending in the longer run (and conversely or net pro ts).

Te state’s risks, taken in the round, might not necessarilyincrease with such operations. I purchasing private-sector assetshelped to revive spending in the economy that might, in principle,reduce the probability o the state paying out larger aggregate wel-

are bene ts and receiving lower taxes later. But the orm o the



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4 Paul Tucker

risk would change and, because the driver was central bank opera-tions, the decision-taker on the state’s exposures would switch

rom elected scal policymakers to unelected central bankers.Seen in that light, the question is what degrees o reedomcentral

banks should be granted, and to what ends, to change the state’sbalance sheet.

A minimalist conception, advanced by Marvin Good riend,among others, would restrict the proper scope o central bankinterventions to open market operations that exchange monetaryliabilities or short-term reasury bills (in order to steer the over-night money-market rate o interest). On this model, the LOLR

unction is conceived o as being to accommodate shocks to theaggregate demand or base money and plays no role in offsettingtemporary problems in the distribution o reserves among banks.

Arguably, this would get close to abolishing the LOLR unction

as traditionally executed. As a governor o the Bank o Englandsaid o the s crisis, when the unction was rst emerging, “welent in modes that we had never adopted be ore . . . by every pos-sible means consistent with the sa ety o the Bank.”

Perhaps more pro oundly, at the zero lower bound the onlyinstrument available to the central bank would be to talk downexpectations o the uture path o the policy rate (“ orward guid-

ance”). All other interventions to stimulate aggregate demand— orexample, quantitative and credit easing—would all to the “ scalarm” o government. And that, not a judgment on the merits o theminimal conception, is my point: what is not within the realm othe central bank alls to elected policymakers, with the attendantproblems o credible commitment and time-inconsistency.

At the other, maximalist end o the spectrum, the central bankwould be given ree rein to manage the consolidated balance sheet,even including writing state-contingent options with different

. Quoted in David Kynaston, “Te City o London,” chapter , one-volume edition (Lon-don: Vintage, ).



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groups o households and rms. Tat would get very close to beingthe scal authority, and cannot be squared with any mainstream

ideas o central banking competencies in democracies .So in one direction, the state’s overall capabilities shrivel; and in

the other, its unctions are effectively seized by unelected centralbankers.

We could try to resolve the question o boundaries throughpositive economics on the effectiveness o different instruments inresponding to the shocks hitting a monetary economy. While thatwork is obviously essential, it is not the approach I take here, partlybecause answers are likely to be hedged about with uncertainty;but, more undamentally, because that approach does not speak towhich arm o the state should be delegated which tools. Te prob-lem appears to be that we don’t know where the wel are advantageso credible commitment are outweighed by the disadvantages o

the loss o majoritarian control, because that looks like a trade-offbetween incommensurable values.I am going to approach the question o boundaries, there ore,

by asking rst what purposes a central bank serves and then whatconstraints are appropriate or independent agencies to havelegitimacy in a democratic republic. As we proceed, the tensionbetween commitment technologies and majoritarian legitimacy

will resolve itsel .

A money-credit constitution

Central banks are the ulcrum o the monetary system: the pivot,as Francis Baring put it two centuries ago when coining the term“dernier resort.”

It is usual to think o their independence as being warrantedby a problem o credible commitment. Tat is a necessary condi-tion, but it is not a suffi cient condition once wider issues than eco-nomic wel are are weighed, such as the loss o democratic control.



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6 Paul Tucker

Te imperative o central bank independence is, I think, political,almost constitutional.

In order to maintain the separation o powers between the exec-utive government and the legislature, the scal tool o the in a-tion tax cannot lie in the hands o an executive striving to stayin power. Otherwise it could avoid, or at least delay, requesting“supply” rom the assembly by in ating away the burden o anyoutstanding state debt or, more generally, by printing money to

nance its needs and increase seigniorage income. Tat societychooses to delegate to an agency rather than rely on tying itsel toa commodity standard to meet this problem is, I believe, down tomodern ull- ranchise democracies being unprepared to live withthe volatility in jobs and output associated with the nineteenth-century gold standard.

On this view, in a at money system the independence o the

monetary authority is a corollary o the higher-order, constitu-tional separation o powers. For the delegation actually to delivercredible commitment, the reputation o the central bank and itspolicymakers must be strapped to their success in maintainingprice stability. Tat is one reason transparency is so important.

Te setup unavoidably becomes richer, however, once weacknowledge that society has chosen, rightly or wrongly, to allow

ractional-reserve banking, which brings the social bene ts oliquidity insurance or households and rms bundled togetherwith the risks rom its inherent ragility and the social costs o sys-temic crises.

Te LOLR unction is called into existence to reduce both theprobability and the impact o those risks crystallizing. Tat takesthe central bank to the scene o almost any meaning ul sociallycostly nancial disaster, whether sourced in economic problems oroperational mal unction, as when the Fed lent hugely to the Banko New York to keep the payments system going in the mid- s.In consequence, central banks have a keen interest in the adequacy



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o regulatory and supervisory regimes, in order to contain themoral hazard costs entailed.

In other words, once private banking (in the economic sense)is permitted, central banks cannot avoid being de acto multiple-mission agencies intimately interested and involved in the unc-tioning o the credit system, since most o the economy’s money isthe credit-money created by the banking system (broad rather thannarrow money). As Paul Volcker said with tragic oresight in his

valedictory Per Jacobsson lecture, “I insist that neither mon-etary policy nor the nancial system will be well-served i a centralbank loses interest in, or in uence over, the nancial system.”

Since unelected power needs raming care ully in democra-cies, the de acto position I have outlined should be recognizedde jure.

I that sounds ridiculously banal, remember that the Federal

Reserve does not have an overall statutory objective to help pre-serve the stability o the nancial system but only objectives tiedto speci c powers: or example, sa ety and soundness or the gen-erality o banks and, since Dodd-Frank, stability or its powersover “systemically important nancial institutions.” In the UnitedKingdom, only since has the Bank o England had macro-prudential and microregulatory unctions ramed in terms o an

objective o stability.Te world I am describing requires not a “monetary constitu-

tion” o the kind advocated by James Buchanan but a money-creditconstitution. By that I mean rules o the game or both bankingand central banking designed to ensure broad monetary stability,understood as having two components: stability in the value ocentral bank money in terms o goods and services, and also sta-bility o private-banking-system deposit money in terms o centralbank money.

. Paul Volcker, “Te riumph o Central Banking?” Per Jacobsson Lecture, . Tequestion mark in the title was underlined during the Q&A.



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8 Paul Tucker

Te idea would have been amiliar to our nineteenth-centurypredecessors. Teir money-credit constitution comprised the gold

standard plus a reserves requirement or private banks (an indirectclaim on the central bank’s gold pool) plus the lender-o - last-resort

unction celebrated by Walter Bagehot. Tat package was de cientinso ar as it did not cater explicitly or solvency—as opposed toliquidity—crises. Worse, as our economies moved to embrace atmoney during the twentieth century, policymakers atally relaxedthe connection between the nominal anchor and the binding con-straint on bank balance sheets—to the point where, on the eve othe crisis, they were over-leveraged and horribly illiquid.

At a schematic level, a money-credit constitution or todaymight have ve components: in ation targeting plus a reservesrequirement that increased with a bank’s leverage plus a liquidity- reinsurance regime plus a resolution regime or bankrupt banks

plus constraints on how the central bank is ree to pursue itsmandate.Compared with the nineteenth century, all ve components o

that schema would need eshing out. Much o the past quartercentury has been spent on the rst—the nominal anchor—andeven that work turns out to be incomplete. But other parts o themoney-credit constitution are even more diffi cult to design. We

have learned that regulatory arbitrage is endemic in nance, sothat any regime or the economic activity o banking would needto cover “shadow banks”—not only de jure banks—and it wouldneed to be richer and more adaptable than could be delivered solelyby a leverage-driven reserves requirement. Nevertheless, that sim-ple conception serves as a use ul benchmark and a reminder thatconstraints on, and supervision o , banking soundness are integralto an economy’s money-credit constitution.

o pursue the regulation o banking would be too big a detourrom the parts o the money-credit constitution that most concern



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me here: what central banks must do (their mandate), what theymay do, and the constraints on them.

Some o the necessary constraints on central banks are implicitin my earlier derivation o their independence rom constitutionalprinciples. Most obviously, rather than simply making the de ni-tional statement that any independent agency must be in controlo its instruments, it is speci cally important that an independentcentral bank should be barred rom lending to government on thegovernment’s direction. (Only the legislature should be able to sanc-tion such lending, and through regular legislation, as with any tax.)

Tat provides one vitally important element o an answer toour question o where the line should be drawn around the capac-ity o the central bank to reshape the state’s consolidated balancesheet. Te outline o other components o the answer emerges

rom considering the legitimacy o central banks as very power ul,

unelected institutions.

Constraints and principles for independent agencies

My broad answer to the general question o conditions or thelegitimacy o independent agencies in a democratic, liberal repub-lic comes in three parts.

First, a policy unction should not be delegated to an indepen-dent agency unless: society has settled pre erences; the objectiveis capable o being ramed in a reasonably clear way; delegationwould materially mitigate a problem o credible commitment; andthe policymaker would not have to make rst-order distributionalchoices. Whether those conditions are satis ed in any particular

eld is properly a matter or public debate and or determinationby elected legislators.

Second, the way the delegation is ramed should meet ve designprecepts: ( ) the agency’s purposes, objectives, and powers should



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10 Paul Tucker

be set clearly by legislators; ( ) its decision-making proceduresshould be set largely by legislators; ( ) the agency itsel , in this

case the central bank, should publish the operating principles thatwill guide its exercise o discretion within the delegated domain;( ) there should be transparency suffi cient to permit accountabil-ity or the central bank’s stewardship o the regime and, separately,

or politicians’ raming o the regime; and, ( ), crucially or theproblem I posed, it should be clear ex ante what (i anything) hap-pens, procedurally and/or substantively, when the edges o theregime are reached but the central bank could do more to avert orcontain a crisis.

Tird, multiple missions should be delegated to a single agencyonly i : they are inextricably linked, and in particular rely onseamless ows o in ormation; and decisions are taken by separatepolicy committees, with overlapping membership but each with a

majority o dedicated members.With the exception o the emergency-powers precept, I shallnot de end those principles or delegation here. Tey might seeminnocuous. But, in act, they pack a punch. For example, ew—too ew—independent agencies have clear objectives, so that highpolicy (decisions on values) is effectively delegated. My immedi-ate purpose, however, is to draw out some o the implications or

multiple-mission central banks.For monetary regimes, some o the package is, o course, amil-

iar. Most obviously, the principles or delegation support instru-ment-independence rather than goal-independence (a test not met

. A preliminary explanation was given in ucker, “Independent Agencies in Democracies:Legitimacy and Boundaries or the New Central Banks,” the Gordon Lecture, HarvardKennedy School, May , . A uller explication is orthcoming. Various o the principles

draw on the work o Alberto Alesina and Guido abellini on whether to delegate to tech-nocrats, o Paul Milgrom and Bengt Holmstrom on the incentive problems o multiple-mission agents, and o Philip Pettit on orging the people’s purposes and on contestability.Among other things, the multiple-policy committee structure is incorporated in the Banko England’s post-crisis architecture.



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everywhere), and also the importance o not making monetarypolicy decisions in order to pursue some distributional goal (as

opposed to policy having distributional effects broadly oreseenby legislators). Te apparent incommensurability between majori-tarian control and commitment technologies turns out to be nomore than a specter. Democracy comes rst, and can choose com-mitment technologies or improving aggregate wel are i it wishes.Democratic legitimacy requires that the people’s representativesdetermine whether the country should be tied to the mast o sta-bility, what that mast looks like (the standards in the money-creditconstitution), and that distributional choicesare not handed oversince the winners and, more important, the losers would not haverepresentatives at the central bankers’ policy table. Te outlines osome constraints on central banks are starting to emerge.

Going urther, three o the requirements or legitimate delega-

tion help to open up, and perhaps dissolve, the distinctions andpotential tensions between the monetary policy regime and theLOLR unction that seemed, at rst sight, so problematic.

Tey are the rst, third, and fh design precepts requiring,respectively, the central bank’s powers and objectives to be set bylegislators; the central bank to state the operating principles thatguide its exercise o discretion; and the need or ex ante clarity

around what happens when a central bank reaches the boundarieso a domain it has been delegated.

The need for regimes

At root, the principles or delegation require delegated responsi-bilities and powers to be ramed as regimes. While that is amiliarin the eld o monetary policy, it is not so obvious that LOLR (orother central bank) unctions have been laid down so care ully andclearly over the past century or more.



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12 Paul Tucker

Operating principles for monetarypolicy: the Taylor rule debate

Even within monetary policy (narrowly understood), there remainoutstanding design questions. One o them preoccupies thiscountry’s legislature right now: whether to mandate in legislationa benchmark rule or the central bank’s routine policy instrument,the short-term interest rate.

Rather than offering a rm view on whether or not the aylorrule should be adopted by the Fed, I shall limit mysel to observingthat the debate can be thought o as being about how to implementthe design precept that an independent agency should enunciateoperating principles. For mysel , that that be done by the agencyis more important than that any particular set o principles or anyparticular instrument-rule be entrenched in a law that is justicia-

ble via the courts.In other words, the principles or delegation require that morebe said than has, perhaps, been said about the constraints in “con-strained discretion.” Whether that should be pursued by mov-ing to a lexicographic objective or by ex post acto publication oresearch on the “rule” best approximating past policy or by alsopublishing explanations o deviations rom past patterns raises a

rich set o issues that is being debated a resh. I will not go intoit here, other than to say that, in order to avoid undue concen-trations o power, we should pre er solutions that strengthen therole o individual committee members to those that would embeda single view. In that sense, there might be a trade-off betweenthe clarity with which the reaction unction is articulated and thedegree to which power is dispersed.



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Dening the LOLR regime

I debates about monetary regimes continue, rather more is neededin many jurisdictions to articulate and explain a regime or theLOLR liquidity reinsurance unction. Prerequisites or any suchregime are that its terms should mitigate the inherent problems oadverse selection and moral hazard; be time-consistent; and provide clarity about the amount and nature o “ scal risk” that thecentral bank is permitted to take on the state’s behal .

Compared with things prior to the phase o the crisis,some questions seem to be settled; or example, nearly all centralbanks now accept and have announced publicly, without legisla-tive override, that they stand ready to lend against a wide range ocollateral, including port olios o illiquid loans to households and

rms. I think it is also now conventional wisdom, as it should be,

that excess collateral should be taken to leave the central bank’sexpected loss no greater than i it had bought reasury bills, asunder the minimal conception.

Other questions remain outstanding in many jurisdictions: orexample, whether there are any circumstances in which the centralbank should be permitted and, i so authorized, would be preparedto lend to non-banks or to act as a market-maker o last resort. Any

re ection on those issues reveals the diffi culty o making credibleclaims that the authorities will never undertake such operations.I that is correct, it would be as well to concentrate on designing aregime or them to do so under appropriate constraints.

O those, surely the most important is that the central bank, abody o unelected offi cials, should not knowingly lend to a rmthat is irretrievably and undamentally insolvent. I “no monetary

nancing” is the golden rule or a credible nominal anchor, so “no

. What ollows is expanded upon in Paul ucker, “Te Lender o Last Resort and ModernCentral Banking: Principles and Reconstruction,” Re-thinking the Lender o Last Resort , BISPaper No. , Bank or International Settlements, September .



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14 Paul Tucker

lending to irretrievably insolvent borrowers” should be the goldenrule or theliquidity reinsurer. Tat “liquidity support” has become,

or many people, synonymous with “solvency bailout” is a tragedyo the rst order that saps away the legitimacy o central banks.

How a central bank lender makes those assessments o solvency, and how it values collateral, should be publicly understoodin broad terms ex ante and, with appropriate lags, be capable obeing assessed ex post .

Tis is not simply about estimating the solvency position o apotential borrower at the moment be ore any liquidity is provided.I the market is in the grip o a liquidity panic affecting an individual rm(s) or the system as a whole, the provision o liquid-ity might dispel the panic and restore the rm’s solvency position.Faced with a problem o multiple equilibria, LOLR interventionsmight be able to get the economy and the distressed rm(s) back

onto a healthy path. I , however, the rm is undamentally bust(has a net assets de ciency) whatever the (realistic) economic out-look, then no amount o central bank lending can provide a cure.

None o that is to say that decisions that are decent ex ante wouldalways generate good or satis actory outturns ex post . Tis is essen-tially about orecasting: orecasting the effect o unusual liquid-ity provision on the path o the economy and asset prices and its

effects on con dence in the rms in question. Making those ore-casts is hard. As with any orecasts, there would be errors, althoughthey should be broadly symmetric over the long run. Since this is,unavoidably, what is going on, it would be better to be clear aboutit, and or central banks to explain how they make such orecast judgments.

Tat is part o what would need to be covered in a central bank’sLOLR operating principles. Ten the nature and potential effectso LOLR liquidity reinsurance would be better understood in gen-eral, and particular decisions to lend (or not to lend) could beevaluated ex post .



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Te legislators’ role, meanwhile, would be to set or bless thelevel o con dence on solvency necessary or liquidity support to

be permitted; and to provide a statutory resolution regime or han-dling irretrievably bankrupt banks so as to make “no” rom theLOLR credible.

It is not obvious to me that many, or perhaps any, o those issueseatured in the debates that led to the re orm o the Fed’s liquidity

reinsurance unctions. In particular, while appeals are made to theimportance o central banks not lending to undamentally insolvent rms, what that means is rarely spelt out and might not bewidely understood.

Regimes have boundaries

What I hope that brie discussion makes clear is that, like mon-

etary policy, the LOLR liquidity-reinsurance unction could, andshould, be ramed as a regime. And as with any regime, it wouldneed to have reasonably well-de ned boundaries.

Tat being so, we have dissolved part o the dichotomy I setup at the outset between systematic monetary-policy regimesand an inherently exible LOLR unction. Like monetary policy,LOLR liquidity reinsurance is capable o being systematic. Admit-

tedly, compared to monetary policy where policy is reset roughlymonthly in most jurisdictions, it is much harder or observersto tell whether the central bank is sticking to a systematic LOLRpolicy because it gets activated relatively rarely. But that does notnegate the point that the regime should have edges—that the cen-tral bank’s discretion should not be unlimited or absolute.

Which, o course, poses the big question o what happens—or,normatively, what should happen—when the edges o any o these

. See Paul ucker, “Te Resolution o Financial Institutions without axpayer SolvencySupport: Seven Retrospective Clari cations and Elaborations,” European Summer Sympo-sium in Economic Teory, Gerzensee, Switzerland, July , .



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16 Paul Tucker

regimes (monetary, LOLR or, indeed, a eld I am not coveringhere, macroprudential) are reached but there is more that the cen-

tral bank could, in principle, do to shif the shape and size o thestate’s consolidated balance sheet in ways that would avert or con-tain a crisis.

What, in other words, is the proper role o unelected centralbankers in the exercise o “emergency powers” and is it realisticthat central banks can credibly commit to staying within their“proper role,” however it is ramed? Te issues are real: what roleshould central banks play in decisions about whether to bail out,

or example, Lehman, AIG, etc., without speci c congressionalsanction? Tey are, moreover, deep. I have encountered a widerange o views on them in the US.

Beyond the boundaries: emergencypowers and “emergency institutions”

Outside the normal purview o economic researchers and poli-cymakers, there is an active and contested debate among politicaltheorists and constitutional scholars about the nature, acceptabil-ity, and even inevitability o “emergency powers” exercised by theexecutive branch o government when a nation is aced with an exis-

tential crisis. At one end o the spectrum are ollowers o the early-twentieth-century German writer Carl Schmitt, who maintainedthat “exceptions” rom normal governance are both inevitable andacceptable. On this view, in a crisis constitutional conventionsand democratic norms give way to what the executive eels it mustdo, revealing the true but usually hidden nature o the polity. Ieconomists wonder what this has to do with us—that surely it’s todo with national security, war, and terrorism, but not our eld—think again. In the years immediately ollowing the – stageo the global nancial crisis, Chicago and Harvard constitutional



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scholars Eric Posner and Adrian Vermeule argued that many o themeasures taken by the US reasury and the Fed ell air and square

within a conception o exceptional executive power.One elegant response to this line o thinking, articulated by

political theorist Nomi Lazar, is that the posited distinctionbetween the “exceptional” and the “normal” is an illusion. First,some crises persist or years, becoming a more or less normal stateo affairs. And small crises occur regularly but, nevertheless, some-times require extraordinary measures: within nance, think o thesavings and loan crisis in the United States, the HIH insurancecrisis in Australia, or the s secondary banking crisis and theearly- s small-banks crisis in the United Kingdom.

Further, and pro oundly, whether or not one accepts the categoryo “exceptional” circumstances in which constitutional conven-tions and rights get more or less junked, democratic accountabil-

ity does not get thrown out o the window so long as the executiveaces the prospect o uture elections.Tat seems to me to be correct and, more practically, to give us

some pointers toward the construction o robust regimes.First, contingency planning should be embedded in central-

banking regimes as ar as possible. We should not deny that cri-ses can occur and that they will meet with, among other things,

extraordinary liquidity-reinsurance actions, unless tightly bindingour hands truly would crush, and I mean crush, the probabilityo their occurring. Given the ubiquity o regulatory arbitrage in ashape-shifing nancial industry, that is hard.

Second, since it is inevitable that any state-contingent contractgiven to the central bank will eventually prove incomplete, it is

. Eric A. Posner and Adrian Vermeule, Te Executive Unbound: Afer the MadisonianRepublic (Ox ord, UK: Ox ord University Press, ).

. Nomi Claire Lazar, States o Emergency in Liberal Democracies (Cambridge, UK: Cam-bridge University Press, ).



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18 Paul Tucker

necessary to state clearly up ront what happens then. For example,i the basic LOLR regime does not include liquidity reinsurance to

shadow banks, should there be provision or that effective ban tobe lifed in an emergency? I so, who should decide? Te needto answer questions like that is precisely the message o the fhdesign precept set out earlier.

But what does it mean? Te most important point is that, as abody led by unelected policymakers, the central bank should notitsel determine where it could reasonably venture beyond previ-ous understandings o its boundaries. Tat should be sanctioned(or not) by elected representatives o the people, because they willbe directly accountable.

Tus, I object less than some to the provision o the Dodd-Frank re orms that requires the Fed to get the permission o thetreasury secretary (afer consulting the president) to conduct cer-

tain liquidity-support operations. In broad equivalence, wherethe Bank o England wishes to go beyond its published rameworkor providing liquidity support, it must obtain the permission o

the chancellor o the exchequer. (Tat provides a healthy incentiveor the published ramework to be as complete as possible, while

recognizing that at best it will only ever cater or the kinds o crisesthat have been experienced, witnessed, or imagined.)

Emergencies in macroeconomicdemand management: credit policy

We have seen that the LOLR unction can be ramed as a regimebut that, since its very purpose is to contain crises, it should be

. Te oddity is that the ormal consent comes rom the treasury secretary, who is no moreelected than the Fed’s governors. Te democratic benediction comes rom the mandatoryconsultation o the president. I assume that this cumbersome construction is adoptedbecause o the convention that the president cannot be made accountable to Congress otherthan via impeachment.



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clear what happens in “emergencies,” de ned as what lies beyondthe regime’s normal perimeter. Although, by contrast, monetary-

policy regimes are ramed mainly or routine use, it is no less truethat their boundaries can be reached, too.

Tus, questions con ronted by central bankers during recentyears included: Can we and should we conduct quantitative eas-ing (QE) against government bonds? Can we and should we buyprivate-sector instruments to stimulate demand by acting directlyon credit premia?

Tose questions received different answers in different jurisdic-tions, in most cases due to constraints in pre-existing laws that hadnot received much prior “compare and contrast” analysis amongcentral bankers themselves, researchers, or political commenta-tors. In Japan, the answer was: yes, yes. In the UK: yes, broadly no. In the United States: yes, and sort o no. In the euro area: yes (afer

extensive debate), and we don’t yet know.Why did I say “sort o no” to whether the Fed could or shouldbuy private sector paper? Legally, the answer was and remainsunambiguous: it may not. But economically the population oinstruments eligible or purchase included the government-backedFannie Mae– and Freddie Mac–guaranteed mortgage-backed secu-rities, so that the Fed was effectively making allocative decisions,

directly subsidizing the supply o credit to households but not torms. It is arguable that the venture would have sat more com-ortably within standard tenets o central banking, and been more

compliant with our “no big distributional choices” precept, i theFed had been able to buy either neither or both o household andbusiness loan port olios. My point is to illustrate the need or morethinking on the construction o these parts o the regime.

. Te UK position was (and, I believe, is) that de jure the Bank o England was not legallyconstrained rom buying private sector bonds, but that de acto it chose not to do so. SomeMonetary Policy Committee members, notably Adam Posen, thought that a mistake.



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Broad principles that could guide debates on such regimesmight include the ollowing:

• Central bank balance-sheet operations should at all times be asparsimonious as possible consistent with achieving their objec-tives, in order to aid comprehensibility and accountability.

• Central banks should minimize risk o loss consistent with achiev-ing their statutory objectives.

• In particular, i they are permitted to operate in private-sector pa-per in order to stimulate aggregate demand, they should operate inas wide a class o paper as possible and the selection o individualinstruments should be as ormulaic as possible, in order to avoidthe central bank making detailed choices about the allocation ocredit to borrowers in the real economy.

Where, broadly, the line is drawn should be the subject o politicalchoice afer public debate. As with emergency LOLR operations, ithe line is moved during a crisis, that too should be determined orblessed by elected politicians.

In a US-type system, that power needs to be either openly del-egated to the administration or consciously withheld. Where it iswithheld, the legislature itsel would have to make any in-crisis

decisions on whether to authorize innovative operations, alongwith whether they were to be conducted by the central bank on itsbalance sheet under its (newly provided) discretion, or by the cen-tral bank as agent or the scal authority, or by the reasury underdelegated scal authority.

Tat line o argument seems to be grounded in the deepestprinciples o representative democracy, but it meets with one veryserious, practical objection, an objection that applies to both the

. An earlier, uller version was set out in Paul ucker, “Te Only Game in own? A NewConstitution or Money ( and Credit) Policy,” Myron Scholes lecture, Chicago Booth Schoolo Business, May , .



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LOLR and monetary policy examples. One could think o it asthe Hamiltonian objection, as it amounts to those in power doing

everything they can to protect the people.

The objection

Say the legislature is sclerotic, and simply cannot bring itsel eitherto delegate authority to the executive branch in advance or to makereal-time decisions itsel in a crisis. And say the public, the Ameri-can people, are desperately threatened by the crisis, which mighteven shatter the stability o society. Should not the agencies that cansave the people act? Should not the US cavalry ride to the rescue?

Or say that members o the legislature publicly oppose thecontemplated action while privately signaling their agreement?Does that license the central bank to act, on the grounds that the

legislature has itsel vacated the moral high ground vested in itconstitutionally?Or what i the legislature is likely to retaliate, once the dust has

settled, by removing some o the central bank’s powers, leaving itless equipped to respond to uture crises? Should the central bankweigh the net present value o its acting today against the prospec-tive costs o its being less able to act tomorrow? Or should it go

ahead irrespective o the prospect o tighter uture constraints, onthe basis that i uture crises are suffi ciently grave, it should sim-ply step around them (just as, in our thought experiment, it hasstepped around “today’s” constraints)?

Tese diffi cult questions, which are not utterly anci ul givenpolitical currents in the United States, turn on more than “narrow”wel are judgments. Tey involve weighing the intrinsic merits odemocracy, and the risks o eroding support or democracy by vio-lating its deepest principles.

My answer, as set out above, remains unchanged: that theunelected leaders o independent agencies cannot rightly take



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22 Paul Tucker

that burden onto themselves. I the legislature cannot or will notrespond in the ace o dire emergency or i it is Janus- aced or i

reprisals are in the air, the moral and political burden o choosingmust all on the elected executive. I the question o emergencypowers challenges some constitutional conventions but, againstSchmitt and with Lazar, it does not undermine our most basicconceptions o democracy, the big choices should be in the handso the elected executive, not unelected technocrats (just as, in a di -

erent sphere, the big decisions do not lie with the military).So let me twist the kni e.What i it would be counterproductive or the president openly

to approve an emergency course o action by the central bank? Incontrast to the military sphere, it is not so easy to claim that thepresident has constitutionally ordained duties and powers in theeconomic sphere o the kind he has as the commander in chie .

In that case, have our “wel arist” objectors got a point? Indeed, istheir argument overwhelming i not acting might lead to a crisisthat would prospectively lead to civil con ict threatening democ-racy itsel ? Should the central bank just do what it thinks to beright, regardless, possibly supported privately by the president?

I cannot see any clear deontological duties here. But nor canI see how a wel areassessment will suffi ce. One almost wants to

all back on old- ashioned Aristotelian ideas o virtue: i.e., i theynd themselves there, we hope to have virtuous central bank lead-

ers who will weigh the short term against the long term, wel areagainst majoritarian decision-taking, and so on. One or two trulygreat men among central bankers rom the past fy years mightspring to mind. Tat eels precious, but also, it must be said, pre-carious. We seem to be stuck.

But we don’t need to resolve our deepest moral dilemmas inorder to shape principles or the design o regimes. And, ortu-nately, a practical prescription does emerge. We must strive to



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shrink as ar as we possibly can the troublesome space in whichthere is neither a within-regime contingency plan nor an ex ante

process with majoritarian credentials or determining in-crisisarrangements. Better to recognize that imperative up ront whendesigning the central banking regime, in line with my fh designprecept or delegating to independent agencies.

Cooperation and coordination with the executive

branch need not negate independenceo recap, then, the big questions or central banking regimes are

(a) what powers should the central bank have during “peacetime”to alter the shape o the consolidated state balance sheet; (b) whatextra powers, i any, should it be granted ex ante to help handlecrises, and what should be the trigger or activating them; and

(c) should the elected executive branch be empowered, by the leg-islature or under the constitution, to increase those central bankpowers during crises.

More effort has typically gone into (a) than (b) and, in most jurisdictions, almost none has gone into (c).

We nd an example o how (b) and, especially, (c) cause con u-sion in a quirk in the different approaches to the political economy

o QE in the US and UK. In the US, there was no coordinationbetween the Fed and the reasury, on the grounds that that couldcompromise the Fed’s independence.

In the UK, we took exactly the opposite view. Since we werechanging the state’s consolidated balance sheet in ways that carriedrisk or taxpayers but could also be offset by the reasury, the Banko England sought and received rom government an up- rontindemnity against the nancial risk entailed and a public under-taking that it would not change its debt-management strategy.In the US, government debt maturities were lengthened, cutting



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24 Paul Tucker

across the Fed’s stimulus. In the UK, that did not happen. Butindependence was not compromised as we decided, in the Bank’s

Monetary Policy Committee, how much QE to do and when.One moral o the story is that independence does not preclude

coordination, on the right terms. Another is that obtaining a sanc-tion to innovate need not threaten independence. Te challenge is

or the central bank to remain the initiator o ideas or the use oits balance sheet.

Joined-up regimes under the money-credit constitution

Summing up so ar, three points have run through this analysis.First, or democratic legitimacy delegated powers need to be con-structed as regimes based on clear general principles. Tat appliesno less to central banks than to other independent agencies, and

applies no less to LOLR and to stability unctions more generallythan it does to monetary policy.Second, the components o an economy’s money-credit consti-

tution (MCC) should cohere. Tat is to say, the regimes or thenominal anchor, or the regulation and supervision o ractional-reserve banking, or the state’s provision o liquidity reinsurance,and or the constraints on how central banks pursue their unctions

must be joined up. At a conceptual level, they should be guided bysome simple benchmarks, even i the reality cannot be as simple aswould be easible in a world that placed a lower value on reedom.

Tird, emergencies should not be enced off or on-the-spot in-crisis improvisation, but should be catered or, substantively andprocedurally, within the overall MCC.

In terms o analogies with the state’s most basic unctions, thecentral bank emerges looking like a hybrid o the high judiciaryand the military. Like the judiciary, the central bank’s insulationmust be secure when it comes to deciding the stance o mone-tary policy. But subject to that constraint, there are circumstances



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where, like the military, its crisis-management repertoire can be,and sometimes should be, determined by elected political lead-

ers. How much such coordination is needed turns on the extent towhich contingency plans have been coded-in up ront. Not easy,but within reach.

Tere is, however, one important complicating actor that I havekept bracketed away. In terms o the results or society, the effectso any money-credit constitution depend on how scal policy-makers conduct themselves. In saying that, I mean more than theelemental point that unsustainable public nances cannot coex-ist with monetary stability. Tere can be a particular problem ostrategic interaction even where the public nances are sound—in

act, perhaps particularly then.

The only game in town: strategicinteraction with the scal authority

Over the past eight years, it has become a common re rain thatcentral banks have been the only game in town. Quite apart romthe discom ort this causes the central bankers themselves as they

ret about unwarranted expectations and possibly also about theirlegitimacy, there are other voices raising the possibility that over-

reliance on central banks has led to in erior economic results orhas entailed risks o impaired per ormance down the road.

Tose sentiments can be detected in a wide variety o argu-ments. O course, some suggest openly that it would have beenbetter to support recovery through public-in rastructure invest-ment, or with tax incentives or private investment, or throughdebt orgiveness. Others ocus more on the costs and risks omonetary stimulus. Tey suggest that the scale and nature o mon-etary easing have created risks to stability through ueling a search

. Tose arguments have been advanced by, or example, Larry Summers, Martin Feldstein,and Ken Rogoff.



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26 Paul Tucker

or yield in domestic nancial markets, or through spillovers intooreign, especially emerging-market, economies that could in

time “spill back,” or by withdrawing “sa e assets” during a periodwhen demand or such assets is unusually strong. Although thepoint is rarely drawn out, the implica

Documents

Central Bank Governance and Oversight Reform, edited by John H. Cochrane and John B. Taylor