Central banker argues for central bank power

BIS General Manager Agustin Carstens gave a speech yesterday Maintaining sound money amid and after the pandemic.

He first summarizes the challenge of "fighting persistently low inflation and economic stagnation in a low interest rate environment." The second half of Carstens' speech received more attention. He highlights "the significant strengthening of the nexus between fiscal and monetary policy" and asks "How can the spectre of fiscal dominance be kept at bay?"

"Central banks have launched renewed large-scale purchases of government debt as part of their crisis response, motivated by the stabilisation objectives within their mandates... At the same time, there is an ongoing debate about the need for greater coordination of fiscal and monetary policy in an environment of reduced policy space due to persistently low interest rates, with some pundits arguing in favour of overt monetary financing. This raises the general question of how central banks can best contribute to economic growth and stability, in the current situation and in general. Is it by directly financing the government?

"I will argue that the best contribution monetary policy can make is always to maintain sound money, to focus squarely on preserving price and financial stability. Support for the government is justifiable in the pursuit of these goals. Otherwise, the risk arises of real or perceived fiscal dominance undermining central bank credibility as the foundation of sound money... the natural boundaries between fiscal and monetary policy need to be respected."

The speech was generally viewed as being more political than economic -- a defense of monetary authorities who simply don't want to lose power relative to fiscal authorities. Economist J. W. Mason summed up the general response: "it would be an interesting exercise, and shed a lot of light on where orthodox thinking is these days, to work out exactly what are the causal links in the implicit model underlying his speech."

The debate about fiscal-monetary overlap will continue for a while because of that strengthening "nexus". The chart below shows the extent of central bank government bond purchases relative to total increases in public debt across countries.